Chicago Foreclosure Lawyer Blog

As I had long suspected, mortgage servicers have very strong financial incentives to push for foreclosure instead of modifying a loan. Diane E. Thompson, of counsel to the National Consumer Law Center, recently published an article in the Washington Law Review that analyzes various servicer incentives and how they prompt servicers to select loan modification or foreclosure.

In general, this decision is based on which approach will make the most money for the servicer. Although servicers will claim that an individual investor or group of investors has refused to entertain the idea of a loan modification, more often than not, investors have very little day-to-day involvement with individual loans. These investors are generally owners of mortgage-backed securities. They do not own individual loans, rather, they own an interest in receiving the proceeds from a large pool of loans.

Many investors are entities like pension funds, retirement funds, and other entities that are seeking a stable, long-term investment. In general, it is in an investor's best interest to keep the pool of loans filled with performing loans. Properties that are sold via foreclosure do not provide long-term income, and in many cases, investors see very little of the funds from the foreclosure. This is due to several factors.

First, given the fact that many properties are underwater, a foreclosure sale very rarely obtains an amount equal to the loan balance. Moreover, a foreclosure sale cuts off long-term gains from interest. A lump sum of $150,000 is worth much less than that same amount paid off over a term of 30 years at 5% interest.

Second, before investors see any return from a foreclosure sale, the servicer is paid. Servicing a loan that is in foreclosure allows servicers to obtain fees for late and missed payments, securing a property, hiring attorneys to process the foreclosure, and other costs. The longer a property spends in default and in foreclosure, the more money a servicer stands to make. Servicers make significantly less money servicing a performing loan over the long-term.

It is also worth noting that when servicers offer loan modifications, they often offer modifications that make economic sense for the servicer, not the investors. Many loan modifications provide for missed payments and the associated penalties by tacking the value onto the loan's principal balance. This means that many borrowers end up owing more after a modification than they did prior to modifying. Another popular strategy is to set aside the missed payments and fees in a separate line item. This amount can be paid down over time by making pre-payments, or it becomes a balloon amount due at the end of the modified loan's lifetime. These loans are more likely to default, sending more business back to the servicer.

Most interesting is why servicers don't generally offer principal reductions -- they are normally paid a servicing fee based on the principal balance of the loan. Reducing principal reduces that fee, which is clearly not in the servicer's interest. Servicers are also rated based upon their efficiency in resolving delinquent loans. Pushing to foreclose can help increase this rating and drive more business to the servicer.

Servicers will also keep borrowers in temporary loan modifications as long as they can. This increases the servicer's profit as it is entitled to keep the majority of its fees and penalties that relate to servicing the loan. Additionally, when a servicer denies a permanent loan modification, it can apply further fees related to the partial payments made under the trial modification. Keep in mind, trial modifications do not modify the loan, they are essentially a reduced payment period designed to test a borrower's ability to make reduced payments.

On the whole, the article is worth reading and is accessible to both academics and lay persons. Look for more updates and analysis in the future.

For those looking for a copy of the article on Westlaw or Lexis, the cite is:

Thompson, Diane E., "Foreclosing Modifications: How Servicer Incentives Discoruage Loan Modifications," 86 WashLRev 0755 (2011).

As the foreclosure crisis drags on, the time it takes to complete the average foreclosure increases. This, in turn, feeds a desire to determine the cause of the slowdown. There are obvious choices such as the incredible volume of foreclosure cases and the home owners in default who have not yet been sued. Logically, if you continue to add inputs to a closed system, it will eventually become overwhelmed by those inputs and cease to function as efficiently. The fact that we have inputs that are just waiting to be added makes this correlation even more obvious.

Even if every plaintiff's firm added 10 new attorneys to their foreclosure divisions, adding more judges is not as simple.

It seems that a meme is resurfacing to explain away the logical and obvious reasons for the foreclosure slowdown. Attorneys and homeowners are to blame. Here are two examples of this trend: CNNMoney and Foreclosure.com's blog. Central to the concept is the idea that homeowners are getting a free ride while their attorneys employ "stall tactics."

According to foreclosure.com, these stall tactics include:

• Challenging the bank's actions


• Waiting to file paperwork right up until the deadline


• Requesting the lender dig up original paperwork


• Declaring bankruptcy ( in some extreme cases)

After the jump, I'll discuss just how a purposeful and strategic foreclosure defense plan protects the rights of the consumer and is more than just a waste of time.

Continue reading "Why Foreclosure Defense Is More Than Just "Wasting Time"" »

Last Friday's Chicago Tribune had an interesting article about a new principal writedown program that Ocwen was rolling out in 33 states, including Illinois.

Underwater loans will be reduced to 95% of the home's value. The written-down portion will remain in an account. If the borrower is current for three years, the account is closed and the amount forgiven.

How is Ocwen getting investors to agree to this? It appears to be via equity sharing.

In this plan, if a home is sold or refinanced, the home owner gets 75% of the appreciation, and the investor takes 25%. The article indicates that it is just the "appreciation" that the owner and investor split. That doesn't seem like much incentive. If we assume that the housing market will eventually rebound, sooner or later home values will begin to rise again. However, I don't see them rising at the rates we saw during the housing bubble. If they do, we will have a bigger problem on our hands.

I am wondering if this actually means that the investor gets 25% of the home's value at the time of the sale. Either way, it does appear to be a good deal for borrowers who can afford the new payments. However, the program requires that the borrower be underwater and delinquent, which I don't like.

Requiring that someone be behind on payments will absolutely result in people entering default in order to qualify for the program. If the program somehow fails those individuals, they will be primed and ready for a foreclosure action. It appears that only 2.6% of borrowers defaulted during the pilot program. Maybe my concerns are overblown.

Let's not forget that mortgage servicers were (and sometimes still are) telling borrowers that they had to be in default to qualify for HAMP and MHA programs. That misinformation put many people in a worse position than they were before. Requiring a default for principal writedowns seems to avoid the "moral hazard" argument, but also sets up a new potential "moral hazard." It's like a mobius strip made entirely of bad ideas.

On the whole, I think this is a good step forward. I do have some misgivings about requiring default in order to qualify for the program, but hopefully it will be a net benefit in the end.

Recently, I've been reading about stealth loan modifications. Banks like B of A and Chase are apparently modifying loans without being asked, even when those loans are current. It appears that many of the loans being modified were Option ARMs. An option ARM is an adjustable-rate mortgage that allowed borrowers to choose how much to pay each month. Payments below the monthly payment amount were merely tacked onto the principal balance.

Lenders like B of A and Chase inherited many of these loans from failed banks that they acquired (like Countrywide and WaMu). It is possible that they are trying to minimize losses by keeping borrowers in homes at rates they can afford. Changing an option ARM to a fixed-rate mortgage (although at a slightly higher interest rate) guarantees a steady return on investment over time that is more certain than allowing a borrower to default.

What is mind-blowing is that these banks are content to write down principal on loans where the borrower is current and not seeking a modification. At the same time, those banks are denying the same relief to borrowers who are underwater and behind, or in imminent danger of defaulting. Keep in mind that these write downs are not being forced by any kind of settlements. These seem to be purely business decisions.

It would seem, however, that a solid business decision would be to also write down the balances of other underwater loans. The foreclosure process is a mess thanks to lenders trying to take shortcuts like the use of robo-signed affidavits and bogus indorsements on notes. Here's a shortcut that doesn't reek of fraud -- write down the underwater mortgages as well. Let's give some loan modifications to people who are in default.

When 25% of the nation's mortgages are upside-down, odds are that property values were artificially inflated during the housing bubble. If we were to adjust those values for the bubble's inflation, odds are that we'd find them slightly higher than the current market value. Yes, that market value is also based on the presence of foreclosures on the market, the shadow inventory, abandoned buildings, etc. However, if we got homeowners back above water, more could afford to and would be willing to keep their homes.

If we took people out of foreclosure and put them into stable loans, we'd fix the mess and possibly spur a housing recovery.

So why aren't we doing it?

To be honest, I don't have an answer to that question. The best I can figure is that the banks are trying to mitigate loss on one front while waiting to see what happens on another. If this settlement with the AGs and the federal regulators goes through (doubtful), then perhaps we will see some settlement-mandated write downs for other borrowers. If the settlement tanks (again), maybe we'll see some other modifications offered. We're certainly seeing more progress in our loss mitigation efforts here in the office already.

If you live in Chicago and have a mortgage, there is a 47% chance that your home is worth less than the mortgage balance. The most recent projections indicate that the housing market won't begin to recover until 2014 at the outside earliest. Some economists are noting that we may be headed for a double-dip recession. Although some home owners may be able to weather the storm, many are going to be stuck with negative equity for much longer than the next three years.

When a home is underwater, mortgage payments can seem futile -- payments towards principal are merely nudging the property towards a break-even point; they are not building equity. If you believe the media, so-called "strategic default" is a big thing these days. Let's ignore the fact that nobody can properly define the term, and focus on concrete options available to Illinois home owners who are underwater on their mortgages.

1. Keep Paying

If your home is only marginally underwater, and you're in an area that is seeing fewer foreclosures, it may make good business sense to stay put. Home owners best served by staying put likely purchased their homes before the real estate bubble took off and did not refinance their homes during the bubble. This type of home owner will likely have stable income as well.

Obviously, this would be the best option as it avoids any negative impact on the home owner's credit. It also keeps the home owner out of bankruptcy and out of foreclosure.

2. Walk Away

Simply walking away from the property is the diametric opposite of option number 1. When the media discusses strategic default, it seems to be discussing this option. However, it sometimes lumps the other options in with this one.

The walk away is simple. Stop paying the mortgage. Move out of the property. Some people mail the keys to the bank. At some point, the bank will foreclose on the property. The way this option is described, the worst-case scenario is almost always a negative impact on the home owner's credit score.

That is not the case. Simply walking away from a mortgage can have other penalties associated with it. When a property is underwater, it is almost guaranteed that a foreclosure auction will not recover the value of the mortgage. In general, properties sell for less than their market value at a sheriff's sale. If a property's market value is significantly less than the value of the loan, a sheriff's sale will not even come close to recovering the loan's value.

So why should the person who walked away care? Isn't it the bank's problem? Yes, if you live in what is known as a "non-recourse" state, the bank is out of luck.

Illinois is a "recourse" state. This means that the bank can pursue a foreclosed home owner for what is known as a deficiency judgment. This deficiency is the difference between the amount owed on the loan and the amount obtained at the sheriff's sale. Once a bank obtains a deficiency judgment, it can put a lien on other property that you may own. It can proceed to garnish your wages. It can freeze your assets while it determines just how much of your money it can obtain to satisfy its judgment.

Suffice it to say that walking away in Illinois is not as hassle-free as it may seem.

3. Deed In Lieu of Foreclosure

The deed in lieu of foreclosure is a remedy available to Illinois home owners. The deed in lieu is created by the Illinois Mortgage Foreclosure Law. You can find the statutory language at 735 ILCS 5/15-1401. Some federal programs like HAFA also provide a deed in lieu option. Some lenders may also make this option available to home owners in states without a statutory version of the remedy.

A deed in lieu of foreclosure avoids the filing of a foreclosure lawsuit. Although the borrower may be in default, or close to defaulting, it is nothing like simply walking away from the property. The deed in lieu of foreclosure protects the home owner from the negative credit reporting associated with a foreclosure lawsuit. It also protects the owner from a potential deficiency action on the underlying loan. The deed in lieu wipes out the entire debt obligation.

The deed in lieu may not be a great option for underwater home owners. While some underwater homes may only have one mortgage, many have multiple mortgages. The presence of a second or third mortgage makes a deed in lieu of foreclosure all but unattainable.

If there is only one mortgage on the property, most lenders require that the property be listed for sale for 90 days before granting a deed in lieu. The lender will also want to see financial disclosures that demonstrate a financial hardship. If you are able to make your mortgage payments, but simply do not see the sense in paying off negative equity, you may not be eligible for a deed in lieu of foreclosure.

4. Consent Foreclosure

In a consent foreclosure, the home owner has been sued by the lender. However, instead of proceeding forward with the foreclosure lawsuit, the lender and home owner agree to settle the matter. The home owner files a stipulation of consent to foreclosure. In return, the lender takes back the property and agrees to waive the right to later pursue the home owner for a deficiency judgment.

This remedy is very similar to a deed in lieu of foreclosure. It is also created by the Illinois Mortgage Foreclosure Law. You can find the entirety of the statute section at 735 ILCS 5/15-1402. There are some key differences.

The first major difference is that a consent foreclosure causes a judgment to be entered against the home owner. This will have a more adverse credit impact than a deed in lieu. However, it is entirely possible to obtain a consent foreclosure, even with other mortgages on the property.

The second and third position lenders can object to the consent foreclosure, but if the property is significantly underwater, their position won't be much different than if the property went to sale normally. This is because there will not be any funds remaining to pay the second and third mortgages. It is important to note that the consent foreclosure only protects the home owner from liability as to the first mortgage. Any second or third mortgage may still pursue the home owner for the balance due on those loans.

If you anticipate opting for a consent foreclosure, it is best to request on as soon as you are served with a summons. If you are represented by counsel, make sure your attorney send the request as soon as possible. This way, you avoid being denied a consent foreclosure because the lender has too much money invested in the foreclosure process.

5. Bankruptcy

The U.S. Bankruptcy Code affords home owners the opportunity to surrender a property as part of a bankruptcy. Under Chapter 7 or Chapter 13, the home owner may elect to surrender the property. One also gets the benefit of discharging other consumer debts.

Chapter 13 may afford underwater home owners the opportunity to strip second and third liens off the property, paying them back as if they were repaying a credit card debt. This tactic may restore equity to an underwater property.

Before considering a Chapter 13 bankruptcy as a means of lien stripping, it is important to consult with a bankruptcy attorney in your area. Different courts allow different things, and lien stripping may not be available to you.

Conclusion

No matter how you proceed, there are many options that could be defined as "strategic default." Aside from lien stripping, the end result is always the same -- the bank ends up in possession of the property. Ignore the people that claim mortgages are a moral obligation. At the end of the day, the only true difference is that most reasonable options involve a minimization of home owner liability, while a true strategic default can result in judgments against the home owner. Those judgments have a rather lengthy shelf-life and can be collected upon in several ways.

It is likely a good idea to consult with a licensed attorney before seriously pursuing any of the above options. Know your options and the possible impact before you act.

According to Zillow and the Huffington Post, roughly half of the mortgages in Chicago are now underwater. This represents an increase of 13% from last year. As more foreclosed properties hit the market, we may see prices dip even lower.

It also looks like Chicago is #5 on the list of cities with the fastest falling home prices.

In the meantime, we're looking at a lot of people who will struggle to regain positive equity on their homes. There are options for people seeking to exit their properties. While the short sale option is largely unworkable in a depressed market, deeds in lieu of foreclosure may be possible. It may be possible to surrender distressed properties or strip second mortgages in a bankruptcy as well. Any solid exit strategy should involve an attorney at the planning stage at very least.

Pro Publica's latest information blast provides an interesting look into how the mortgage industry and HAMP failed to provide solutions for home owners. I particularly like the way the data is presented; I love graphs and charts.

For the most part, I think the information is presented without manipulation. There is one particular data point that leaves me wondering whether the blame rests 100% on the servicer's side. According to the second graph in the piece, roughly 66% of delinquent borrowers were not in contact with their servicer. The paragraph explaining the graph implies that servicers should have been more proactive in contacting delinquent borrowers to discuss alternatives to foreclosure. I agree with this sentiment. Obviously, there is not going to be a data set for "dodged servicer calls" or "servicer calls unrelated to alternatives."

The graph demonstrates a key point in preventing foreclosure: home owners must be proactive and contact their lenders. Waiting for the servicer to call is a bad strategy. Avoiding talking to the servicer is an even worse strategy. Hoping the servicer will just offer a loan modification is the worst possible strategy. Dealing with servicers can be an exercise in frustration. However, it's a necessary step in the loss mitigation process.

To cap off National Consumer Protection Week, I have read the 27-page proposed settlement between the state Attorneys General and the mortgage lenders.

There are groups on both sides of the debate that are less than happy with the proposed settlement. I happen to think it's not too bad for a first draft. Some highlights after the jump.

Continue reading "Highlights From The Proposed Foreclosure Settlement" »

The magic of the scheduled posts often means that I draft an article days before it goes live. During the in-between time, the world continues on without heed to whether my scheduled post will continue to be relevant.

Although the cash figures remain in the neighborhood of $20 billion, some more details about the proposed settlement can be found in this New York Times article. The proposal itself may have some problems. It appears to task the newly-formed CFPB with enforcement powers. However, the same agency is risks defunding. Perhaps some of that $20 billion figure can go to keeping the lights on.

The basic gist of the proposal is simple -- no more batch work. Each mortgage is to be considered individually. No foreclosures can proceed if the borrower is attempting a loan modification. No more serial trial modifications; three successful trial payments would net a permanent modification. Denied modifications would automatically garner third-party review.

The proposal means that banks would have to slow down foreclosures or hire more people. For a country that needs to generate some jobs, the latter option seems like a no-brainer. This might also reduce the number of properties in foreclosure, which should then improve the housing market.

As more details are released, I will post more information. The settlement process seems to be in its early phases, but I'm hopeful that we'll see a final resolution by the summer.

In the summer of 2008, Aurora Loan Services offered some of its adjustable-rate mortgage customers an opportunity to modify their loans. The modification would lock in the five-year teaser rate for another five years. For ARM borrowers facing a change date, this likely seemed like a good deal. To qualify, the borrower had to make two more payments on time -- the modification would be automatic after that point.

According to a recently-filed lawsuit, the only way those offered the deal could decline it was to default on the mortgage. Given the drastic drop in interest rates that followed the economic crisis, borrowers who received the modifications ended up paying significantly more than if they had allowed their mortgages to adjust as normal. This is the tricky bit about ARMs -- if interest rates go up, your rate goes up. If they go down, your rate goes down. Locking your rate for several years is only beneficial if interest rates increase.

As we discover more information about the origins of the financial crisis, it seems rather obvious that someone at Aurora knew the modification scheme was a good bet for the bank. The lawsuit, filed in Utah, seeks class action status. The plaintiff, Andrew WeissMalik, is hoping to find out how many borrowers received the modification offer during the discovery process.

Given that it was next to impossible to decline the modification, I am left wondering how these modifications can be considered valid. The only means of declining the offer was to breach the contract -- acceptance was indicated by continuing to honor its terms. In contract law, we would say that the modification lacks consideration. The borrowers were not required to take any extra steps or sacrifice anything to receive the modification. Simply complying with the existing contract was their assent.

Hopefully we will see more news about this case as it progresses.

You can read more about the lawsuit here.

This post's title may paint a rosy picture, but not if you're evaluating the performance of the HAMP program. While 1.76 million loan mods were issued in 2010, over two-thirds of those modifications were processed through internal, lender-specific programs.

According to this article, a little over 500,000 of the modifications initiated in 2010 were HAMP modifications. The remaining 1.2 million were in-house programs.

While this is good news for those seeking loan modifications, it begs the question -- what happened with HAMP? In my humble opinion, HAMP didn't have enough carrot or stick. There was no reason for lenders to push HAMP modifications -- we didn't provide enough early incentives or penalties.

More telling is a statistic deeper into the article -- 20% of the borrowers in a permanent HAMP modification by the end of 2009 were 60 days delinquent by the end of 2010. Why? Because banks were failing to effectively underwrite those modifications, and because the economy still hasn't rebounded. While Wall Street may be seeing gains, the truly important numbers -- unemployment and housing -- are still dismal.

This is why it is important to combine litigation with your loss mitigation strategy -- for many home owners, litigation provides extra time for an individual's financial situation to improve.

The Treasury Department released loan-level data on the 2.5 million borrowers who sought aid under HAMP on Monday. The Consumer Law & Policy Blog has some initial analysis of the numbers.

The vast majority of applications weren't denied because the investor didn't feel the deal wasn't worth it. On the contrary, many of the people applying didn't meet the criteria set for HAMP. Even those denied for permanent mods after attempting a trial mod weren't generally nixed for failing to make payments. They were nixed because their income was too high or for other reasons that would have been ferreted out had lenders been required to pre-approve borrowers for permanent modifications before starting trial mods.

CLPB's verdict is that HAMP wasn't destined to fail, but that it was mismanaged, overly complex, and unable to deal with the issue of principal reduction. I would have to agree with this assessment.

According to the New York Times, a new state law in California is making it difficult for loan modification-seeking homeowners to obtain an attorney's assistance. This isn't because attorneys aren't allowed to assist homeowners in obtaining a modification, it's because they cannot charge the client any money until the work is complete. Anyone who has attempted to get a loan modification can tell you that the process can take months upon months to complete. During that time, the attorney has costs to cover and bills to pay. Some modifications fail. So, in that case, what is "completed" work?

As a result, many attorneys are just turning away potential clients who want help with their loan modifications.

This is an example of a regulation that fails to work as planned. The obvious intent was to prevent fly-by-night attorneys and mortgage rescue companies from fleecing California residents. Since California is largely a non-judicial foreclosure state, attorneys cannot simply make loss mitigation part of the services they offer in addition to litigation. The result of this rule is that people's access to the legal profession is limited by market forces, which means more people will likely lose their homes. This, in turn, increases the shadow inventory and ultimately delays the recovery of the housing market and the economy overall.

Illinois prohibits non-attorneys from taking up-front fees for loan modifications. I would imagine that we attorneys are allowed to take up-front fees because we have the attorney disciplinary and registration commission to deal with those attorneys that defraud their clients. You'd think that California has a similar regulatory body . . .

I have previously posted about Attorney General Madigan's desired changes to the Illinois Mortgage Foreclosure Law. Her proposed changes have finally been introduced into the Illinois General Assembly. You can look up the text of HB 6951 at the ILGA website, or you can keep reading. After the jump, I break down the most interesting bits.

Continue reading "Illinois Attorney General Madigan's Proposed Changes to the Illinois Mortgage Foreclosure Law" »

This is something I harp on frequently. I don't think it's excessive; I see ads for "get out of debt" companies on television on a daily basis.

While Illinois state law already protects Illinois residents from scams where credit repair companies charge up-front fees, the Federal Trade Commission has issued new rules that prohibit these companies from charging fees until services are provided. It is worth noting that prohibiting the practice won't stop frauds from being frauds. However, if the up-front fee wasn't a red flag before, it should be now.