Loan Modifications: An Exercise in Futility?

by: Markham Lee

There has been a lot of press lately about lender sponsored loan modification programs, aimed at helping someone avoid foreclosure by modifying their loan in a fashion that makes the situation more manageable. However, a recent NY Times investigation found that few (if any) homeowners facing foreclosure are actually helped. The NY Times found that many lenders are difficult for homeowners to work with and/or are proposing solutions that aren’t financially viable for the homeowner. The common solution of, moving missed payments and late fees to the end of the mortgage, or adding them to the principle, doesn’t help much when you can’t afford the payment anyway.

The primary problem seems to stem from the fact that these homeowners are behind on payments, may be facing financial hardships, have high interest rates (due to an ARM reset), etc and simply can’t afford the mortgage. Whilst modifying the terms, moving late fees around, etc, may help over the short term, nothing short of a benefactor who pays the late fees, missed payments, etc, coupled with a significant cut in the interest rate is going to save the day.

So, if we understand that affordability is the root cause of the foreclosure crisis, what’s the solution? I’m not one to advocate bailing people out of bad decisions, but having hundreds of thousands (if not well over a million) homes go into foreclosure, short sale, people just walking away, etc, isn’t good for the country, let alone the financial sector. The only solution I see is for the lenders to take a REAL look at loan modification, as opposed to “playing the game” for PR purposes.

The loan servicers, originators, investors need to sit down and figure out how much it’s going to cost them to foreclose on the home vs. cutting the interest rate by 2-3 points. They need to look at each borrower’s situation and if they have an instance where cutting the rate from 10% to 8% results in a borrower that can afford his/her payments, they need to do what they need to do to make that happen. It’s not about bailouts, helping people or anything else, it’s just business: if cutting the interest rate by 200 basis points results in a smaller loss than the foreclosure process, than it’s a wise decision to cut the rate.

Granted, no for profit business wants to get into the habit of simply cutting prices whenever a customer can no longer meet their debt obligations, but these are unique circumstances. Somewhere around ‘01/’02, lenders forget that part of their job as wise lenders was to originate loans that the borrowers had a good chance of paying, by originating loans with little documentation, teaser rate ARMs to people who could never afford the reset rate and just bad loans in general, many lenders guaranteed that a significant percentage of their customers would go into foreclosure.

Unique situations call for unique solutions.

Understandably, I’m being simplistic, there are legal agreements at play, and some agreements don’t even allow significant interest rate cuts. BUT, I figure the “masters of the financial universe” can figure out a true solution if they have to. It’s a simple thing, what’s more expensive: foreclosure or a significant cut in interest rates that everyone from the original originator, the servicer and the investors all agree to?

Warren Buffett says the #1 rule is “Don’t lose the money”; maybe the financial sector should listen to Warren and start implementing viable solutions for loan modification. This foreclosure problem is going to get out of hand and we could be seeing 500k foreclosures/month before long, the banks will make more money and the nation will suffer less if a “stop-loss” solution like the one I propose is implemented.

It’s simple math, if cutting the interest rate results in a smaller loss than foreclosure, cut the interest rate. I’ve never been one to excuse homeowners or lenders for their bad decisions, but I don’t see why the nation (as a whole), shareholders and banking profits need to suffer when we can elect to take the route of least financial loss.

I understand that my solution would probably help out a lot of irresponsible people AND lenders, but I think the alternative is a lot worse.

Finally, if the Banks can’t or unwilling to implement loan medications programs that will stem the foreclosure tide, then please stop the charade and pretending like a significant number of loans are being modified. It’s insulting to investors, the general public and your customers especially. But be forewarned, if the foreclosure crisis does indeed reach the epic levels it has the potential to, due in part to lender negligence with respect to underwriting standards, the inevitable Government intervention, regulations, etc, may be far worse than the cost of the financial sector implementing a solution of its own.