Jun282011

Loan modifications are not an entitlement, banks don’t want to make them one

Lenders and borrowers are stuck with each other. Lenders know everything about their borrowers, and most lenders believe their borrowers are capable to making their mortgage payments. Unfortunately, when they are severely underwater and paying more than a comparable rental, borrowers don’t want to make their payments. A poor compromise is a loan modification. They haven’t worked out very well.Loan_Mod_Dance

Why is housing market stuck? This family offers one answer

By Bob Sullivan — June 27. 2011

CHICAGO — Ron and Cheryl Schmalz think they know one reason the U.S. housing market is stuck. They just spent more than two years and created about 50 pounds’ worth of paper trying to get a $300-per-month modification to their mortgage.

Whoa! Wait a minute. What is the connection between the housing market being “stuck” and people having difficulty getting a loan modification? If everyone who wanted one were given a loan modification would the market suddenly get unstuck? Of course not. The banks are still in denial that they gave out a bunch of free money. If they have to write off the debt in loan modifications, they truly would be giving out free money. They won’t do that.

Nearly every month for the past two years, the Schmalzes received a warning from their mortgage holder, JP Morgan Chase, that the bank was about to foreclose on their home and that late fees were mercilessly piling up. Nearly every two months, the couple would dutifully fax in a pile of paperwork reminding the firm that they were participating in its loan modification program and making trial payments prescribed by the bank.

“We had 17 different relationship managers,” said Ron Schmalz. “They just make you file the same papers again and again and again. And each time you get a new manager, you have to start over. The last time we thought we had a permanent modification, we got another call that said, ‘Hi, I’m your new representative.’ It makes you crazy.”

At some point, perhaps after the 10th different “relationship manager” doesn’t it dawn on people that their lender doesn’t want to give them a loan modification?

It reminds me of the Publishers Clearinghouse Sweepstakes. You can enter the contest without buying their magazines, but they will resend you the paperwork with another query to buy a magazine. After about a dozen mail ins, if you still haven’t bought a magazine, they will begrudgingly enter you in the sweepstakes. They make people fill out endless paperwork over and over again because they don’t want to enter people into the sweepstakes who don’t buy magazines.

The same is true for loan modifications. They make people fill out endless paperwork because banks don’t want to give the loan modification. Why would they? Particularly if they can get borrowers to keep making partial payments, they will shine those people on as long as possible. As far as the bank is concerned, these borrowers are the living dead, so squeezing a few extra payments out of debt zombies is gravy to them.

Further, if lenders did start giving out loan modifications, everyone would want one. Who wants to pay back their full mortgage balance under onerous terms when banks are giving borrowers better deals?

There are many troubling clogs in the mortgage pipeline that are keeping the housing market stuck — lenders aren’t lending; there are too many homes for sale; there’s a lack of buyers because of poor employment prospects.

I have read the statement that lenders aren’t lending many times. It isn’t true. This is a sensationalist claim that implies lenders are capriciously hurting the economy and the housing market.

It is true that lenders are no longer giving unlimited amounts of free money to anyone with a pulse. Hopefully, we will never return to the complete lack of standards and accountability of the housing bubble. However, lenders stand ready to loan money to anyone who meets appropriate lending guidelines. There just aren’t that many of those people available.

But one critical clog is the limbo faced by homeowners who can’t afford their full mortgage payments any longer but who could survive if their loans were refinanced or modified. In 2009, the Obama administration launched its Home Affordable Modification Program (HAMP), estimating it would help keep 5 million families in their home — and keep 4 million empty houses off the market, critical to the health of the housing market.

Did anyone who wasn’t engaging in wishful thinking really believe the government would be able to execute 5 million loan modifications? The announcement had all the features of symbolic politics, with perhaps the exception of the appointment of a foreclosure czar.

Also, I dislike the pandering in this article when he says the program would keep “families in their home.” It isn’t their home, it never was. They borrowed a huge amount of money, often with nothing down, to occupy real estate. Underwater loan owners have the same claim to real estate a renter does: none. They have no equity. The only thing they own is their loan.

At the same time, banks committed to continuing their similar, parallel proprietary modification processes.

The Schmalzes’ odyssey is a window into the challenges faced by homeowners looking for help, by government regulators trying to prop up the failing market and by banks trying to pick the right bets among mortgage holders who might be able to pay some, but not all, of their monthly payments.

The Schmalz family has a happy ending. After two years of effort, the monthly payment on their Chicago-area home was reduced from about $1,175 a month to $861. It’s not a free ride: Their original $90,000 mortgage is now a $98,000 mortgage, and the couple will make up for the lowered payments with additional payments on the end of the loan.

In other words, these borrowers converted their fixed-rate mortgage to an Option ARM. Do you remember the terms on Option ARMs? Temporary payments less than the fully-amortized amount with the principal being added on to the mortgage balance, and increasing payments in the future: those terms are a proven disaster, but they make up the core of loan modifications.

Still, the break the couple got in April represents the end of a nightmare that began in September 2008, when Ron lost his job in telecommunications and the couple told the bank it needed help. It’s a Red Tape wrestling match that Ron Schmalz says can break the spirit of homeowners who might otherwise be able to ride out the rough employment market.

“You keep going and you keep giving and you keep doing and you keep faxing and you keep calling to no avail. And you just feel like you’re a gerbil,” said Ron. “You’re sitting in a wheel going nowhere.”

That’s because they are gerbils, or sheeple if you prefer. If they were trying to give lenders more money or new business, do you think the process would have been so difficult?

Right after losing his job, Ron Schmalz began working with Washington Mutual, the original mortgage holder, on the modification paperwork. By early 2009, it was clear the application was in trouble, as Chase’s acquisition of Washington Mutual had thrown things into disarray. After a few rounds of resubmitting required tax forms, income statements and monthly budgets, the Schmalzes were denied.

Ron Schmalz had found a new job by then, albeit at a lower salary, and for a few months in 2009, the couple tried to keep up with their $1,100 payments. But then Cheryl lost her job, they missed a payment, and they resubmitted their application. Working with Chase’s proprietary modification program, rather than the government’s HAMP program, they were given a temporary modified payment around $800 per month. The couple says they dutifully made the new payments beginning in January 2010 and were told that within three months that Chase would decide whether the adjustment would be made permanent or rescinded, so either way, they could move on with their lives.

Then, 14 months passed.

What is the bank’s urgency to do anything? The took a loan in default and got the people to make $800 per month payments, and they didn’t have to agree to anything. The bank is going to allow that situation to go on indefinitely. They have bigger problems with other loans to deal with.

Letters saying “We are prepared to start foreclosure proceedings” arrived every month. Ironically, they all included instructions on how to enter a loan modification program.

Almost as frequently, the Schmalz family says, they were told they’d forgotten to submit a tax form or an income form, or that their file was incomplete, so no decision could be made. With nearly every conversation, there was a new “relationship manager.”

“It’s about obstacles. It’s about what they placed in front of us to make this modification a reality. It made things very difficult,” Ron said.

Of course they did. They don’t want to make the process easy because they don’t want to give out loan modifications. This isn’t a story about a bad program that needs to be streamlined. The banks have no desire to streamline this process or make it any easier. They want to get whatever they can out of borrowers, and if providing a dangling carrot leads borrowers to make at least partial payments, banks will do that.

There’s no way to know who’s to blame for paperwork mishaps, but the Schmalzes brought quite an organized pile of documents and file folders with them to show a reporter.

“Things got so tense that we were at each other’s throat, saying: ‘Did you file this? Didn’t you file that?’ You know, sometimes blaming each other,” said Cheryl. By that point, they’d fallen behind by $10,000, and “the tune of our conversations with Chase got nasty.”

They were $10,000 behind on their mortgage payments. What did they expect, invitations to the Chase Christmas party?

In the middle of 2010, the couple turned to Illinois Attorney General Lisa Madigan looking for help.

After a flurry of complaints dogged the various loan modification programs, Madigan’s office had created a special division to deal with consumers facing the Schmalzes’ plight. The agency gets about 200 calls per week to its mortgage help hotline, said Christine Nielsen, who heads the division. It brought on two full-time housing counselors to help homeowners submit loan modification requests to banks; still, she’s seen the difficulty consumers have when working with banks. Despite a flurry of complaints about modification applications in late 2010, homeowners are still being left in the lurch.

Loan modifications are not an entitlement. As I noted last year, Loan Modifications Succeed by Increasing Borrower Entitlements. “If people are not forced to cut back discretionary spending before they obtain a government bailout, taxpayers are subsidizing their discretionary spending. The standards of what constitutes discretionary spending from essential spending depends greatly on the the spender’s sense of entitlement.”

How many of the people calling the hotline looking for the loan modification they deserved were unwilling to cut back on their lifestyle extravagances? Remember Calculated Risk’s post HAMP applicants tanned and juiced?

“Consumers are still having a fair amount of difficulty getting answers from banks about their loan modification applications,” she said. She said the Schmalz case was typical of the problems consumers are encountering, but some are much worse. One recent applicant was turned down for a modification by another bank (not Chase) because of a difference of $20 per month, she said.

Banks have to draw a line somewhere, and no matter where that line is drawn, someone will just miss it.

Chase wouldn’t discuss the specifics of the Schmalz case, other than to say the firm provided the family with a “special forbearance” in 2010 and a modification in 2011.

“In general, we need complete and current information from a customer to make a modification decision,” a Chase spokesman said.

Timely processing of modification applications is essential to the housing market recovery, said Madigan.

Why? Loan modifications are not essential to a housing market recovery, so timeliness is certainly not necessary. The timely processing of foreclosures is essential to the housing market recovery, but nobody wants to deal with that reality.

“Our nation continues to be in the grips of a home foreclosure crisis of unprecedented proportions. Meaningful loan modifications — ones that truly reduce a homeowner’s payments to affordable levels — can save homes, yet people often face serious obstacles attempting to navigate the loan modification process on their own,” Madigan said. “Resources provided by my office and other HUD-certified housing counselors can help people received a modification by ensuring banks comply with federal modification guidelines.”

Reducing payments to affordable levels after the fact does not save homes. By converting these loans to Option ARMs, they merely delay the inevitable foreclosure. These homes should never have been imperiled in the first place through foolish lending. Making sure lending does not get stupid again is the only thing that can save homes and sustain ownership.

As the modification process drags out over months, or even years, it’s easy to understand the problem facing both banks and consumers. Generally, banks are working off an affordability formula based on income. Financial circumstances change; applicants can and do lose or recover income after they submit an application, which requires a recalculation. That explains part of the delay faced by the Schmalz family.

In the real world when someone gets laid off or can no longer afford their house — they have to sell it and move. Now, once you have obtained a certain level of housing entitlement, apparently you get to keep it forever even if you can’t afford it any more.

Here’s my new retirement plan. In my late 50s, I will borrow the maximum I can at the peak of my salary. Then a couple of years later, I will retire and demand a loan modification based on my social security income. Since I am entitled to a loan modification, they should reduce my payments to what I can now afford. That way I get to keep a McMansion on a retiree’s income.

Excessive delays, however, lead inevitably to such changes. A family that applies for help because of a loss of income will be working immediately to replace that income. That places them squarely in a catch-22 — success finding a job could lead to failure in a loan modification application or, more specifically, in the conversion of a temporary to a permanent modification.

Duh! If someone finds a better paying job, they no longer need the loan modification, do they?

The delays leave the family in a perpetual state of uncertainty, with a pile of threatening bank letters rising. It also leaves the housing market in uncertainty — no one knows how many trial modifications will ultimately be rejected, with the likely outcome that the owners will lose their home and the house will be thrust onto the already-saturated housing market.

I’ll give you a hint. Over time, they all will fail. Even in the early stages, the failure rate is 75%. Why would that number improve?

The most recent data on the administration’s HAMP modifications show that only about one-third of 2 million modifications have been made permanent. Millions of other homeowners are engaged in proprietary bank modifications.

Even as the bills and foreclosure notices piled up last year, Nielsen’s office told the Schmalzes to keep making their trial modification payment in order to demonstrate their ability to satisfy the lowered obligation. Finally, in April, the Schmalzes got the good news they’d been dreaming about.

“Essentially, we got a refinance,” Ron Schmalz said. “But they could have done this at Day 1 for us. We’re not upset with the result; we’re happy with it. We’re just upset with the process. We just don’t understand why it took this long.”

That’s the question nearly every observer of the housing market is asking about a potential recovery.

Yes, the lender could have given these borrowers and the millions of others loan modifications on day 1, but that would cost them billions more than they are already losing. Once the word gets out that loan modifications are easy to get, everyone will want one. Foreclosure Is a Superior Form of Principal Reduction.