Failed promise of mortgage modification

by Henry Lane, Attorney
Lane & Hamer, Whitinsville, MA

Failed Promise of Mortgage Modification

As the economy continues to struggle, the avalanche of mortgage foreclosures has continued unabated.  In past year, a mortgage lender's right to foreclose was largely theoretical because somewhat more conservative lending standards typically ensured that homeowners had at least some equity in their homes and therefore, even if they lost jobs or otherwise fell on hard times, they were able to sell the property for at least the amount of the mortgage prior to any foreclosure action.

In more recent years as lending standards became more lax and many homebuyers were able to obtain financing for one hundred percent of the purchase price of their homes, the equity cushion disappeared.  Furthermore, as property values declined, even homeowners who had a significant down payment or had built up equity by paying down the principal balance on a mortgage loan discovered that their equity had disappeared.  Homeowners who then ran into financial difficulty were no longer able to sell their homes for the amount due on the mortgage and, therefore, had little recourse but to allow their bank to complete the foreclosure process.  Occasionally homeowners who owed more on their mortgage than their home was worth were able to arrange so-called "short sales" with their bank accepting less than the full amount owed on the mortgage; but, in many cases the homeowners discovered arranging a short sale was not worth the time and effort required, particularly if the bank was still going to hold them responsible for any deficiency in the amount the bank received from the sale.

As more and more people in the middle class found themselves unable to keep up with their mortgages, various legal and legislative efforts were undertaken in an attempt to keep people in their homes.  Unfortunately, despite some marginal success, the various legal and legislative efforts have been of limited utility.  As with so many social problems, an effective solution to the mortgage foreclosure crisis requires balancing the interests of several competing constituencies.  Any solution that mandates mortgage modification risks imposing ruinous losses on financial institutions and/or the public treasury.

One of the first major efforts to address the issue was the Bankruptcy Reform Act of 2005, which was designed to tighten up the bankruptcy provisions.  Among the proposals for inclusion in the Bankruptcy Reform Act was a provision that would have allowed a bankruptcy court to modify a homeowner's mortgage to reflect the current market value of their home.  So, if a homeowner purchased a home for $300,000.00, financed it with a mortgage loan of $280,000.00 but a subsequent drop in real estate values reduced the value to $200,000.00, the homeowner could request the bankruptcy court to modify the mortgage balance to $200,000.00 and reduce the monthly payments accordingly.  Financial institutions naturally opposed the proposal since they considered it to be somewhat one sided in that it was available to homeowners even if they were able to make the payments originally agreed to and didn't allow the banks to recover their losses if the value of the property increased in future years.  Congress ultimately rejected the loan modification provisions for first mortgages although it did provide that individuals filing bankruptcy under Chapter 13 (a so-called wage earner plan) agreeing to make partial payments on their debts, could wipe out a second mortgage or equity line of credit if there was not enough equity in the home to support it.  Despite the fact that Congress ultimately did not give the bankruptcy court authority to modify first mortgages, there have been other legal efforts to encourage loan modifications.

At the federal level, two major efforts were the Making Home Affordable program created by the Financial Stability Act of 2009 and the February 2012 settlement with five national mortgage servicers that encourage banks and other lenders to modify loan terms for qualified home owners who are struggling to make mortgage payments.

Cooperation by banks and other lenders in these efforts would appear to be motivated by the reality that it does not make economic sense for a bank to go through the expense of foreclosing on a mortgage if the homeowner is willing to make payments that reflect the current value of the property.  Obviously, after foreclosure, a bank will only be able to sell the foreclosed home for its market value.  If the current homeowner is willing and able to make payments based on the reduced market value, the bank can realize the same economic benefit without the risk or expense of an actual foreclosure, and the homeowner may be able to maintain good credit.

Despite the fact that these efforts at mortgage modification seem to make economic sense for both banks and homeowners, the programs have not yet been notably successful. For many people the prospect of having to make significant mortgage payments for another 20 or 30 years with a modified mortgage to keep a home in which they have no equity and which may actually be continuing to lose value is not very attractive.  Since most banks and other lenders are not willing or permitted to pursue homeowners for loan deficiencies after foreclosing, many people have apparently decided that it makes more sense to simply walk away and start over.  Unfortunately, this increase in abandoned properties creates public safety problems and further decreases neighborhood property values making it more difficult to stabilize the housing market.

For more information on federal loan modification programs see www.makinghomeaffordable.gov and www.nationalmortgagesettlement.com.

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