Mortgage investors, regulators need to make sure banks do right thing
Banks that collect fees from servicing delinquent loans and foreclosures don't always act in the best interest of the mortgage investor or the homeowners, who are better served by a loan modification. Guest columnist Rory O'Sullivan urges regulators and investors to solve this dilemma.
Special to The Times
PERVERSE incentives and dysfunctional corporate bureaucracies within the country's largest banks have devastated the lives of Washingtonians. Often, foreclosure hurts the investors who own the loans as well as the homeowners. As an attorney working on the front lines of the foreclosure crisis, I see the damage caused by the mortgage mess every day.
Take, as an example, an elderly couple I worked with recently. I will call them Harold and Edith. Harold took out a loan on his house to pay medical bills when his brother fell ill. His brother later passed away and Harold fell behind on the payments as he was no longer receiving help from his brother.
Harold and Edith diligently worked with their bank to obtain a loan modification, providing new sets of documents more than a dozen times. Eventually, the bank approved Harold and Edith for a modification under the federal government's modification program. Unfortunately, their success was short-lived. Harold and Edith found out the following week that the bank had failed to stop the foreclosure sale.
In this case, the investor, the company that owns Harold's loan, would have been better off had the servicing bank stopped the foreclosure sale. Harold and Edith receive Social Security, so they would have been likely to continue making their modified loan payments for years to come. Instead, the investor now owns a foreclosed home and will not be able to recover the loan principal after the foreclosure fees and realtor's commission are paid.
There are around 6,000 new foreclosure filings in Washington state every month. Many of these filings happen in cases like this one, where the investor would be better off working with the homeowner rather than foreclosing. However, the servicing banks collect fees from servicing delinquent loans and from the foreclosure process. This means that the incentives of the servicing banks often run counter to the goals of the investors holding the loans and the goals of the homeowners.
Thirty years ago, borrowers would go to their bank, apply for a loan, and then work with the loan officer directly if they had trouble paying their mortgage. Today, because the bank servicing the loan is usually separate from the investor holding the loan, borrowers are unable to communicate with a bank that is acting in the investor's interest.
Millions of homeowners owe more money than their home is worth. Many homeowners, like Harold and Edith, can make payments that will benefit the investor more than foreclosure would. However, modifying the loan in a way that benefits both the borrower and the investor would require the servicing bank to give up the fees they receive for servicing a delinquent loan. It would also require the servicing bank to spend time and resources reviewing and verifying income records and other documents. This is the step banks often failed to complete when the loan was first made.
The current incentive structure hurts homeowners, their communities, investors and the economy as a whole. In Harold and Edith's case, I have threatened to file a lawsuit if the bank does not undo the foreclosure sale. The threat of a lawsuit may be enough to convince all the parties involved to reverse the damage caused by the servicing bank's foreclosure. Unfortunately, many other homeowners in foreclosure will not be able to find an attorney willing to file a lawsuit on their behalf.
For the mortgage market to start functioning properly again, mortgage investors will need to ensure that the servicing banks act in their interest and banks will need to hold a greater percentage of the loans they originate and service in their own portfolio. However, until this happens, states attorneys general, legal-aid lawyers and private attorneys must protect homeowners' interests by forcing banks to follow the foreclosure laws and abide by their agreements with the federal government.
These actions protect not only the homeowners and their communities, but they often result in a better outcome for the investor and the economy as a whole.Rory O'Sullivan is an attorney at Northwest Justice Project, a nonprofit law firm, and an adjunct professor at Seattle University School of Law. The views expressed are O'Sullivan's and do not represent the views of Northwest Justice Project or of Seattle University School of Law. Legal extern Xi Yang, a law student at the University of Washington, contributed to this article.