Why Banks Won't Modify Your Loan


PHOTO: Long Billed Vulture (or Indian Vulture) - Gyps indicus. Wikimedia commons. Nidhin Poothully from Bangalore, India.Ever wonder why banks have been so slow to modify home loans on the brink of foreclosure? I have. Well, part of the answer may have just been revealed in a recent story in London's Financial Times.

The story is about the resistance of some investors to get back into real estate, especially as the federal government winds down its programs that have propped up the market. Big investors like BlackRock, a leading bond investor, that once put money into home loans are staying on the sidelines because of an unresolved fight in the financial markets. If these investors continue to turn up their noses at bonds backed by mortgages, that would mean less money available for homes loans and higher interest rates as a result.

The dispute is over who bears the brunt of losses on distressed mortgages, in particular those linked to a second lien, as is often the case. And it goes a long way to explaining why banks have seemingly sabotaged the government's efforts at foreclosure prevention.

For the last year, the news has been full of stories about the flailing federal Home Affordable Modification Program run by the U.S. Treasury and the Department of Housing and Urban Development. The program has provided more than a million temporary loans modifications to borrowers who are on the brink of losing their homes to foreclosure.

The banks and mortgage companies that service many of these mortgages seem unable or unwilling to make these temporary modifications permanent. For more than a hundred examples, check out the comments to this story, in which homeowners rail against loan servicers who seem determined to drive them out of the Home Affordable program and into foreclosure (JP Morgan Chase is singled out in particular, though Wells Fargo, Citibank, and PNC Bank also earn mentions).

The resistance of many banks to modify loans never made any sense to me, since a home sold at a foreclosure auction often sells for much, much less money than it bring through a conventional sale. Also, a significant number of foreclosed homes are damaged once their owners are forced out, which only drags the value down further since it's hard to sell a home that's covered in spray paint with broken windows. Banks should be highly motivated to avoid having to seize and auction properties.

But it turns out banks have another motive. Many of the banks that service home loans also have made second mortgages to these properties, as the FT points out. A second mortgage is subservient to the first mortgage, so the first mortgage is supposed to be paid first.

That means if the terms of the primary loan are changed, the secondary loan could be wiped out. Some secondary mortgage lenders are fighting to share the losses with the primary lender, according to the FT.

BlackRock, for its part, argues that banks will have to take their losses before the company steps up its purchases of non-government backed mortgage bonds.

"In many cases the person owning the second lien is also servicing the mortgage and running the [modification] process," said Curtis Arledge, chief investment officer for fixed income at BlackRock in an interview with the Financial Times. "There's potential for conflicts of interest."

Potential conflict of interest? If the second mortgage holder is about to take a huge loss but also has control of the modification process, why not delay the process? The secondary mortgage lender probably has little to lose and a fight with the primary mortgage lender could potentially lead to a better deal. It's a little like vultures fighting over a corpse.

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