Why Won’t My Lender Modify My Home Mortgage?
By: Patrick MacQueen, Esq.
The likely solution to Arizona’s housing problem would seem to be a program in which borrowers could obtain meaningful loan modifications from their lenders – i.e. loan modifications in which lenders reduce principal balances. Yet, most borrowers desiring a loan modification are eventually turned away by their lenders – despite months and months of paperwork, telephone calls, and frustrating correspondence.
Undoubtedly, meaningful loan modifications would be in everyone’s best interest. Principal loan reductions would provide many borrowers with “breathing room" in their personal finances, which would, in all likelihood, stimulate growth in other sectors of the economy. Indeed, the more money in borrowers pockets, the more borrowers will spend in the retail, tourism, and financial services sectors – not to mention the incredible benefit to the real estate industry. Lenders would benefit by saving significant foreclosure costs that are incurred before, during, and after a foreclosure occurs. In fact, the post-foreclosure costs alone can be considerable. Accordingly, until a buyer is found, the lender must maintain the home, which necessarily includes payment of (a) real estate taxes, (b) upkeep costs, (c) homeowners insurance; and (d) home owners association dues.
Given the obvious benefits of loan modification to lenders, it seems rather odd that a lender would prefer to foreclose rather than give a borrower a legitimate opportunity to modify their loan. However, while it may seem counterproductive for a lender to foreclose on a mortgage, there are powerful incentives for a lender to string a borrower along and eventually foreclose on a mortgage – as opposed to modifying it.
The chief impediment to meaningful modifications appears to be due to the role of the loan servicer as opposed to anything else. A loan servicer is typically employed by the original lender (or investor) to distribute monthly loan statements to borrowers, and collect and allocate monthly loan payments on behalf of the original lender (or investor). And, it is the servicer that deals with the borrower’s request for a loan modification. To this end, it is the servicer’s financial incentive to, in many cases, favor foreclosure as opposed to modification.
To explain, in the majority of serviced loans, a loan servicer’s fees are based upon the overall principal balance of the loan. Consequently, reducing a borrower’s principal balance would necessarily reduce the servicer’s fees. A large-scale principal reduction program would put many servicers out of business. Furthermore, servicers derive additional income through the imposition of late fees, late interest, and other default charges collected from the proceeds received at a foreclosure sale (before any proceeds are given to the “underlying investor").
An additional reason that servicers prefer foreclosure includes the fact that certain tax laws treat foreclosures more favorably than principal reductions. And, from a financial perspective, the costs associated with hiring, training and paying new employees provides an additional, strong disincentive provide loan modifications on a large-scale basis.
Because of these strong, disincentives (and many others), it is rather obvious why loan servicers favor foreclosure – foreclosures are better for the bottom line. Without a doubt, servicers are rewarded for keeping a borrower in default and almost always lose money by modifying a principal balance. As a result, until servicers are motivated to provide meaningful modifications, the likelihood of borrowers obtaining a principal reduction remains slim.