By Columbia – Lexington Bankruptcy Attorney Lex Rogerson
Chapter 13 is one potential way to prevent or stop a foreclosure, but others may be better.
As a bankruptcy attorney, I frequently consult with homeowners from all over the midlands — Lexington, Aiken, Newberry, Orangeburg, and everywhere in between — because they are behind on mortgage payments and are in foreclosure or fear they soon will be. Before jumping into a bankruptcy solution, I typically review whether there may be a better approach that would keep them in their homes.
This is the first in a series of articles in which we examine those alternatives, beginning with loan modification.
What is loan modification?
Foreclosure represents a financial loss, not just for the homeowner but also for the mortgage company. For this reason, lenders have long maintained loss mitigation departments that seek to turn problem mortgage accounts into accounts that, while not as profitable as originally intended, at least avoid big foreclosure losses. This can occur by renegotiating interest rates, deferring or forgiving arrearages, or even writing off principal.
This process, guided by lender self-interest and subject to guidelines the lender itself establishes, continues today in some situations. But two things have occurred to change the scenario — one tending to decrease the frequency of loan modification and the other tending to increase it.
The first occurrence is the breakup of the mortgage industry into companies with specialized roles in the process. This development is called securitization. Nowadays the folks who stand to gain or lose if a mortgage goes bad are not the shareholders of a bank or financial institution. Instead they are a group of investors who have bought into a trust that buys bundles of mortgages, seeking a profit off of the mortgage interest. But the trust, which we refer to as the holder of the mortgage, takes no real part in the administration of the loans — the billing and collection of the payments, the enforcement of the legal remedies, and the decisions when problems arise. That role is occupied by servicers who are paid fees for certain things they do. The servicer doesn’t take the profit if a particular loan performs or the loss if it fails, but it really calls the shots on what happens with the loan.
Since the onset of securitization, servicers have usually been reluctant to modify loans. The reason was best explained by Diane Thompson of the National Consumer Law Center in a study called “Why Servicers Foreclose When They Should Modify and Other Puzzles of Servicer Behavior.” Long story short, Ms. Thompson concluded that the pooling and servicing agreements (PSA’s) incentivize foreclosure by allowing servicers big fees for their role in that process while paying servicers less for modifying loans.
Anyone who has been involved in the loan mod process knows that the reluctance of servicers to modify produced an application process that sets up every conceivable barrier to successful modification. To begin with, the servicer requires a huge amount of information from the homeowner. The servicer’s requirements as to form are picky and often silly; for example, some servicers will not accept any page of documentation that does not have the loan number actually written at the top, even if it appears later on the page. When the homeowner misses one of these silly requirements, the servicer will sometimes reject the application, claiming the proper documents were not submitted — never explaining how the documents were inadequate. And here’s the classic method to torpedo a loan mod: the homeowner submits a perfect package, including, say, income information for the three prior months. The servicer sits on the application for weeks, and the homeowner meanwhile hears no response. Then the servicer writes that the application cannot be approved — because the income information is not current!
Tricks like this led the US government and the attorneys general for 49 states to sue the five major mortgage servicers a few years ago. The settlement of that suit required some reforms such as designating a single point of contact for each loan mod application. The process seems to have improved somewhat, but you still get the impression servicers are being dragged kicking and screaming into modifications.
The other development is the emergence of government programs such as the Home Affordable Modification Program (HAMP). An initiative of the Obama administration, HAMP originally set a goal of reducing the homeowner’s mortgage debt service payments, including principal, interest, real estate taxes, property insurance, and homeowners’ association assessments (PITIA), to 31% of the homeowner’s gross income.
The main difference with HAMP is that the rules of the system are set by the federal government, not the mortgage lenders.
Because of several factors, HAMP is not always a solution.
- Not all servicers are HAMP participants. Institutions that accepted TARP bail-out assistance were required to participate, and many other servicers have agreed to participate, but some servicers remain outside the system.
- HAMP does not apply to more recent mortgage loans.
- Some homeowners have either too little or too much income to qualify.
- Only one HAMP modification is allowed every two years.
- The application requirements still trip up some homeowners.
Loam modification, either according to lender standards or under the HAMP program, can change mortgage terms in ways chapter 13 cannot by reducing interest rates or sometimes even writing down the loan balance. When it works, this process can not only avert foreclosure but also make home loans significantly more affordable. But it doesn’t always work. When it doesn’t, a homeowner may want to consider chapter 13 bankruptcy.
In our next article, we’ll discuss a special, federally-funded program in South Carolina designed to reduce foreclosures.