Here's what Pete's strong post on mortgage modification didn't say: it may not make as much sense for a servicer to modify a mortgage as policymakers...and the rest of us...want to believe.
For the uninitiated among us, a mortgage servicer is the institution that collects your monthly mortgage payments and handles all of the day-to-day administrative needs. A mortgage investor is the person or institution that actually owns the loan. They may be the same, as when a lender makes loan and holds it in its portfolio rather than selling it to someone else. But in an era of securitization and mortgage-backed securities, mortgages are increasingly owned by someone other than the institution or company (remember all those subprime mortgage companies located in Southern California?) that made the loan. The investor may not have the capacity or the desire to service the loan themselves, so they contract with another institution -- the servicer -- to do it.
Here are several things to consider:
- For years I've been told that it costs $50,000 or so to foreclose on a home. But I've been unable to find any analysis that confirms that number. It seems to be more of a legend than anything else. (Please let me know if you've seen an actual analysis that verifies the cost).
- In other words, the cost of foreclosing may actually be less, and perhaps much less, than we've been led to believe.
- So an investor is first faced with a very basic question: What's the cost of foreclosing compared to the cost of modifying the loan?
- If, as I'm increasing coming to believe, the cost of foreclosing isn't as much as we've been told, it make make simple economic sense not to modify.
- But the calculation for an investor likely has at least a second level. A modified loan means that the value of the mortgage has been reduced. Not only does this mean that the investor's revenue stream is reduced, but it also may mean that the overall value of the home and, therefore, the security, has fallen. That reduced value may not have to be recognized until the modification has been completed. As a result, not modifying may actually be the right decision for the investor.
- The real problem, however, may come for an investor who has borrowed against both the revenue stream and the value of the underlying security. A modification, or many modifications affecting the same security, could trigger a margin call for the investor and, therefore, a need to come up with substantial additional cash.
- So an investor could be faced with the need to reimburse a servicer for the out-of-pocket costs of modifying a loan and with the need to come up with additional cash to meet margin requirements. That's simply not likely to encourage them to agree to a modification.
Wait, you're saying, isn't the same thing true of a foreclosure? Won't an investor have out-of-pocket expenses and have to write down the value of the underlying security?
Absolutely. But, it's not clear to me when, after a foreclosure, the reduced value of the home actually has to be realized. If there's no short sale or auction for the property and the home simply stays vacant, does it continue to be valued at the original price if there's been no new assessment or market-determined revaluation? The revenue stream from the monthly payments is obviously gone, but what about the value for accounting purposes?
Finally, everyone seems to be assuming that there are only two choices: foreclosure or modify. There's actually a third choice -- do nothing, that is, don't foreclose or modify. The homeowner may stay in the home and make no payments, but there's no out-of-pocket costs for either the modification or foreclosure and the home stays on the books at the original value.
The do nothing strategy may make even more sense if an investor thinks the economy is going to recover relatively soon. Property values may start to rise, unemployment may start to fall, and the ability of the homeowner to make his or her mortgage payments may increase. At that point the servicer at the behest of the investor may be able to go after the homeowner for unpaid mortgage payments plus interest and penalties, especially if the homeowner has been notified that they are in arrears. In the meantime the investor has incurred no legal or other costs.
If the do nothing strategy is real and the economy continues to recover, we should expect far less modifications in the next six months than anyone has been predicting or hoping.
There is an additional
There is an additional problem which carries a lot of weight with lenders: if one loan is modified and the next door neighbor learns about this, the neighbor is likely to want a modification too. It does not matter whether the neighbor can afford to continue making payments, he will view this as only fair treatment since his house has declined in value too. Lenders are very aware of this issue, and recognize that it is in their best interest to suffer a greater cost on fewer loans by foreclosing, rather than being pressured into modifying a much larger number of loans where borrowers still have the ability to pay.
Modifications
Another option we're seeing here in Florida (ground zero for past, present and future housing busts)---sue for a judgment on the outstanding balance of the defaulted note, but don't foreclose.
The lender may not want to own the property (Chinese drywall anyone?), and maybe there are other assets it can chase. Or the lender may believe that the borrower has the ability to refinance, perhaps with another lender, but prefers the status quo. A judgment gives the lender some leverage to force the borrower to the table.