The Real Reason Your Lender Won't Modify Your Loan?

There are quite a few people who have tried to work with their lender to modify their mortgage who have ended up in foreclosure for one reason or another.

It has even gotten to the point where the Obama Administration has enacted a plan to start fining lenders who can’t find a way to modify more loans.

The banks are not doing a good enough job,” Michael S. Barr, Treasury’s assistant secretary for financial institutions, said Friday. “Some of the firms ought to be embarrassed, and they will be.”

“We’re seeing a failure by some of the bigger banks on execution,” Mr. Barr said. “We’re going to be quite focused and direct on particular institutions that are not doing a good job.”

If the issue has gotten to this point – where fines are going to be handed out and the NYTimes is writing about it – it is clear that there are many people who are frustrated and wondering why it is so difficult to get a loan modification done.

Here is one possible answer as to why it is so difficult to get a loan modification done:

The FDIC has set up sweetheart deals with lenders called “loss sharing agreements” that financially encourage lenders to foreclose rather than modify a loan.

An excerpt from the most well-articulated thoughts on the subject that I have seen: (be prepared to be floored when you read the entire post)

When OneWest took over Indymac, the FDIC and OneWest executed a “Shared-Loss Agreement” covering the sale. This Agreement covered the terms of what the FDIC would reimburse OneWest for any losses from foreclosure on a property. It is at this point that the details get very confusing, so I shall try to  simplify the terms. Some of the major details are:

  • OneWest would purchase all first mortgages at 70% of the current balance
  • OneWest would purchase Line of Equity Loans at 58% of the current balance.
  • In the event of foreclosure, the FDIC would cover from 80%-95% of losses, using the original loan amount, and not the current balance.

How does this translate to the “Real World”? Let us take a hypothetical situation. A homeowner has just lost his home in default. OneWest sells the property. Here are the details of the transaction:

  • The original loan amount was $500,000. Missed payments and other foreclosure costs bring the amount up to $550,000. At 70%, OneWest bought the loan for $385,000
  • The home is located in Stockton, CA, so its current value is likely about $185,000 and OneWest sells the home for that amount. Total loss for OneWest is $200,000. But this is not how FDIC determines the loss.
  • ‘FDIC takes the $500,000 and subtracts the $185,000 Purchase Price. Total loss according to the FDIC is $315,000. If the FDIC is covering “ONLY” 80% of the loss, then the FDIC would reimburse OneWest to the tune of $252,000.
  • Add the $252,000 to the Purchase Price of $185,000, and you have One West recovering $437,000 for an “investment” of $385,000. Therefore, OneWest makes $52,000 in additional income above the actual Purchase Price loan amount after the FDIC reimbursement.

At this point, it becomes readily apparent why OneWest Bank has no intention of conducting loan modifications. Any modification means that OneWest would lose out on all this additional profit.

Although I don’t pretend to know everything – it has generally been my experience that in America, banks are organizations that are designed to follow economic laws (translation: their sole intent is to make a profit).

So when wondering why your lender won’t modify your loan, you may be well advised to follow the trail of money – as in what is going to make your lender more money.

And if the FDIC is literally agreeing to pay hard dollars to the lender to foreclose rather than modify?

It seems to me that someone might want to investigate this issue further and then start talking about possible ways that it could be fixed.

Related Information:

Making Home Affordable Performance (see page 3 for individual lender performance)

Anatomy of a Government-Abetted Fraud: Why IndyMac Always Forecloses

NYTimes: Treasury Pushes Firms For Loan Relief