Archive for March, 2009

Loan Servicers Sloppiness Exposed

Saturday, March 21st, 2009

For quite some time, there have been complaints that the reason why so many homeowners have defaulted, and foreclosure levels are so high, is because “they don’t have enough skin in the game.” The theory is that homeowners who have put little-to-nothing down on their home purchase are more likely to default than those who’ve contributed a substantial down payment, because they have less to lose if their home goes to foreclosure. By extension, it is believed that those with larger down payments will exert more effort to avoid foreclosure and keep their homes.

This line of reasoning seems both logical and intuitively on-target.  So, let’s apply the same thinking to the loan servicing industry.

In my series, one of the things that I focus on is that loan servicers are pretty lax in their standard of care when it comes to handling loans in default, and properties headed to foreclosure.

One of the fundamental reasons for this sloppiness, in my opinion, is that the loan servicer has very little to lose if a property goes to foreclosure. The monthly servicing fee on any one given loan is a very small portion of the monthly payment. If your measly little loan is worth somewhere between $65-200/month to a servicer, exactly how motivated do you expect them to be to give you a loan modification and help you to avoid foreclosure?

Add to that the fact that they’ve got tens to hundreds of thousands of loans to service, and it’s clear why a servicer might prefer to see you go, rather than help you to keep your home. And, your loan is eating up resources, so they’re probably losing money on your file. Add to that the fact that they have to advance to the investor the payments you haven’t made, they’ll probably recoup those costs more quickly by foreclosing than completing a loan modification.

So, I’m having difficulty seeing why this lack of skin in the game theory isn’t being applied to servicers. Recently, Calculated Risk had a story on . It seems that some servicers have let a few homes go for significantly less than “fair market value,” whatever that means in today’s climate. Apparently, some investors have been buying these REO homes and then flipping them without having to improve the properties.

For many years, the problem with the handling of REO’s is that the lenders were asking retail prices for homes that were in awful condition. Miraculously, they were often getting these prices. Instead of selling the properties to competent professionals who would buy them at reasonable cost and make the necessary improvements, they were foisting them on retail buyers. Many of these homeowners-to-be were financially unsophisticated, with weak credit scores and more mechanical skill than capital. They’d buy these homes with the easy financing that was available at the time, and later find themselves woefully short of cash to make the needed repairs. This eventually led to a glut of repairs in really awful shape, which were increasingly difficult to unload.

Now, the pendulum has swung in the opposite direction in some cases. Faced with bloated inventories, these homes are being packaged and sold in bulk. Occasionally, a home is re-sold for significantly less than its retail value. Well folks, when you buy in bulk, you’d best have a few gems in there, or it’s not worth making the purchase.

For those completely aghast at this prospect, I suggest you pick up a copy of Thomas Sowell’s “Basic Economics” and read the section on the value of middlemen. While it’s popular to bash middlemen who take a cut of potential profits, holding out for the last dollar on every single piece of inventory is inefficient and would likely cost more in the end to collect than letting a few good ones go with the bad ones. And believe me, there are a LOT of bad ones in every bunch. 

The actions of some servicers that I’ve seen border on a violation of fiduciary duty. And some have clearly crossed the line. The crux of the matter, in my opinion, is the low margin in this business, leaving servicers with very little interest in any one given loan.

The excuse that some lenders offer is that, “We’re swamped.” or “We service X million loans.” This sounds to me like, “We’re big, so we suck.” Of course, out of the other side of their mouths, they’re promoting their size as an asset to potential borrowers who are in search of a home loan.

On the other hand, I recently dealt with a “Mom and Pop” shop that seemed hell-bent on foreclosure, looking for any excuse possible to take away the home, rather than offer a loan modification to a borrower who would have been a slam dunk at any major servicer.

Of course, this particular investor had very little “skin in the game” themselves, having just acquired the note for what was likely pennies on the dollar. Funny what a game changer “skin” is in the area of loan modifications for those who want to avoid foreclosure.



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The New Federal Housing Plan: A Good Start

Wednesday, March 11th, 2009

On February 17, the Obama Administration announced its new . On March 4th, as to how the new plan would be implemented. Despite criticism from all sides, I think the plan is about as good an approach as is possible in the current political and economic climate.

Many articles and blogs that are critical of the program have pointed out the obvious — that the plan won’t apply to many who could use the help, or even to the majority of people at risk of foreclosure, especially those who are losing their jobs at such a rapid rate. There will be widespread injustices in that many people who deserve to get help will fall outside of the guidelines and an equal number of people who get help may arguably not deserve it. The plan is structurally insufficient given the lack of adequate funding. The mortgage modification part of the plan will crash and burn when (not if) the investors sue because they feel it favors the banks and homeowners and neglects their interests. And so on and so forth.

The fact is, there is no way to create a massive housing relief and foreclosure prevention program without its share of problems — big problems. Still, the Administration’s plan appears to successfully thread a very thin needle by making large and hopefully permanent improvements in the home mortgage landscape while avoiding the worst of the moral hazard bunkers — a political necessity.

The plan consists of two components: a $400 billion refinance program and a $75 billion mortgage modification program (all to be paid out of previously allocated funds). Setting aside the details for a moment, the programs will likely accomplish two important goals:

  • The refinance program will potentially transform millions of funny-money loans with uncertain interest rate futures into stable, 15- or 30-year fixed-rate low-interest mortgages. Payments on the refinanced loans will increase in some cases, but the homeowner’s participation will depend on his or her ability to afford the new loans. And even though their payment may be higher in the short term, it will be stable in the long term — no more fear of interest resets. While the refinance program only applies to mortgages owned or backed by the two large federal housing finance agencies — Fannie Mae and Freddie Mac — we’re talking about half of the nation’s mortgages. Overall, the program is bound to have a substantial — and positive — effect on the mortgage default rate and the stabilization of home prices.
  • Equally important, the mortgage modification program creates a workable approach to modifying mortgages so that payments for many will be brought within the affordability range. Also, for the first time, homeowners can get an objective fix on whether they are eligible for a modification. It’s impossible to say what the future holds for the real estate industry, but it makes sense to believe that once mortgage lenders become comfortable with the very idea of modifying loans, only good things will follow. Whether or not the number benefiting from this program will be in the millions — as predicted by the Administration — or in some lesser amount doesn’t really matter. The overall numbers are sure to be large.

Getting back to the details, let’s continue with the refinance program: Even if you have a shot at this program because your mortgage is owned or backed by Fannie Mae or Freddie Mac, you will only qualify if what you owe on the mortgage is within 105% of the home’s current value. For example, if your property is valued at $200,000, you won’t qualify for refinancing unless you owe $210,000 or less on your first mortgage. This means you probably won’t benefit from this program if you live in the areas most heavily impacted by the housing crisis — home values in these areas are frequently 25% or more below what’s owed on the mortgage. You also will probably be disqualified if your loans are jumbo rather than conforming (over $417,000 in most areas, and $729,750 in higher-cost areas like New York and California).

But suppose you’re lucky and live in a part of the country where you’re just a little upside-down, within the 5% range. Even then you’ll need a good payment history (some say good credit is also required) and an income that is adequate to afford the payments under the new loan, which, as mentioned, may be higher than under your current loan, at least for a little while.

In the final analysis, the homeowners who least need a refinanced mortgage are the most likely to get one, and vice versa of course. And this says something very important about both of the new programs: They were carefully crafted so that the Obama Administration could credibly assert that only responsible homeowners would be helped. They didn’t want to defend themselves against the allegation that we taxpayers were rewarding bad behavior — the moral hazard quandary. In the case of the refinance program, only homeowners who have a good payment history and who aren’t very much upside down are getting to play. Homeowners who somehow got in way over their head or who have shirked their payment duties will likely not be invited to the party.

The Administration’s attempt to only help responsible homeowners is also evident in the mortgage modification part of the program. To qualify for a modification you have to show:

  • financial hardship caused by change of circumstances, such as loss of a job, a medical emergency, or an interest-rate reset (if you were in over your head from the beginning, it’s unlikely you’ll qualify for help)
  • risk of foreclosure, meaning you have missed at least two payments, or your debt to income ratio (your DTI) is higher than 31%, and
  • sufficient and provable steady income (by way of a tax return and wage stubs) to make the payments required under the modified loan.

The ball starts in the mortgage servicer’s court. All participating mortgage servicers (so far, most of the big ones have signaled their willingness to play along) must perform an initial “net present value” (NPV) analysis on all loans in their portfolios that are either at least two months delinquent or that are in “eminent risk” of default. Although the guidelines don’t define what “eminent risk of default” means, I assume it means loans with a debt to income ratio in excess of 31%.  A loan’s NPV is what it would cost (in cash flow) to modify the mortgage relative to the cost of foreclosure and is to be calculated according to parameters set out in the guidelines. Based on past practices, most NPV analyses will favor modification and in those cases the servicer will be required to notify you, proceed with modification discussions with you, and modify the mortgage, assuming you meet the other eligibility requirements.

The ultimate goal for the modification program is to adjust the interest rate and duration of the mortgage so that the homeowner has a debt to income ratio (DTI) of 31% (meaning the payment on the first mortgage, including taxes and insurance, will be 31%of the homeowner’s gross income; the mortgage debt that goes into this DTI ratio doesn’t include payments on a second mortgage, installment payments, or mortgages on other houses).

The modification is to be accomplished by first reducing the interest rate to as low as 2% and then by extending the term of the mortgage (from its inception) to a maximum of 40 years. Once the payment (through this process) reaches a DTI of 38%, the government will share the cost of the rest of the reduction down to 31%. The servicer also has the option of modifying a mortgage loan by reducing its principal — with government participation and backing. Last but not least, the program provides monetary incentives to servicers for keeping people in their homes and to lenders for agreeing to modify the mortgage. 

Both programs are designed to operate without the need for homeowners to come forward with a request for assistance. Rather, the servicers will be contacting people for a follow up after their initial eligibility for a modification or refinance has been established. Nevertheless, it would be a good idea for you to consult with a HUD-Certified Housing Counselor to see whether you are being treated fairly under the new plan. To find a counselor, call 1-888-995 HOPE.

Under no circumstances should you pay a counselor for his or her services. A bevy of mortgage brokers have been retrained to modify mortgages under the new plan (in fact, a new trade organization has been created just for “loan-modification experts”) and are charging outrageous fees for doing absolutely nothing that a HUD-certified housing counselor won’t do for free. Some new mortgage modification companies are hiring lawyers to be front-people for them so that fees can be collected in advance (something that many state laws prohibit). And it’s true that lawyers can sometimes be very helpful in preventing foreclosures as such. But, as with mortgage brokers, lawyers have no magic keys to the kingdom of mortgage modifications. Again, for that purpose, you and your wallet will be better off with a HUD-certified counselor.

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