Loan modification is the systematic alteration of mortgage loan agreements that help those having problems making the payments by reducing interest rates, monthly payments or principal balances. Lending institutions could make one or more of these changes to relieve financial pressure on borrowers to prevent the condition of foreclosure. Loan modifications have been practiced in the United States since the 1930s. During the Great Depression, loan modification programs took place at the state level in an effort to reduce levels of loan foreclosures.
During the Subprime mortgage crisis, loan modification became a matter of national policy, with various actions taken to alter mortgage loan terms to prevent further economic destabilization.
United States 1930s During the Great Depression in the United States a number of mortgage modification programs were enacted by the states to limit foreclosure sales and subsequent homelessness and its economic impact. Because of the shrinkage of the economy, many borrowers lost their jobs and income and were unable to maintain their mortgage payments. In 1933, the Minnesota Mortgage Moratorium Act was challenged by a bank which argued before the United States Supreme Court that it was a violation of the Contract Clause of the Constitution. In Home Building & Loan Association v. Blaisdell, the court upheld the law imposing a mandatory mortgage modification.
United States 2000s According to the Federal Deposit Insurance Corporation (FDIC) chairman, Sheila C. Bair, looking back as far as the 1980s, "the FDIC applied workout procedures for troubled loans out of bank failures, modifying loans to make them affordable and to turn nonperforming into performing loans by offering refinances, loan assumptions, and family loan transfers."Sheila C. Bair, FDIC Chairman, Remarks on the IndyMAC Loan Modification Announcement (August 20, 2008).
The U.S. housing boom of the first few years of the 21st century ended abruptly in 2006. Housing starts, which peaked at more than 2 million units in 2005, plummeted to just over half that level. Home prices, which were increasing at double-digit rates nationally in 2004 and 2005, have fallen dramatically since (see Chart 1). As home prices decline, the number of problem mortgages, particularly in sub-prime and Alt-A portfolios, is rising.[Alta-A loans are those made under expanded underwriting guidelines to borrowers with marginal to very good credit. Alt-A loans are riskier than prime loans because of the underwriting standards of the loans, not necessarily the credit of the borrowers.] As of third quarter 2007, the percentage of sub-prime adjustable-rate mortgages (ARMs) that were seriously delinquent or in foreclosure reached 15.6 percent, more than double the level of a year ago (see Chart 2).Mortgage Bankers Association, National Delinquency Survey Q307 (data cited not seasonally adjusted). The deterioration in credit performance began in the industrial Midwest, where economic conditions have been the weakest, but has now (2006–2007) spread to the former boom markets of Florida, California, and other coastal states.
Chart 1
Chart 2
During 2007, investors and ratings agencies have repeatedly downgraded assumptions about sub-prime credit performance. A Merrill Lynch study published in July estimated that if U.S. home prices fell only 5 percent, subprime credit losses to investors would total just under $150 billion, and Alt-A credit losses would total $25 billion.Merrill Lynch. "Mortgage Credit Losses: How Much, Where, and When?" (July 20, 2007) On the heels of this report came news that the S&P/Case-Shiller Composite Home Price Index for 10 large U.S. cities had fallen in August to a level that was already 5 percent lower than a year ago, with the likelihood of a similar decline over the coming year.
The complexity of many mortgage-backed securitization structures has heightened the overall risk aversion of investors, resulting in what has become a broader illiquidity in global credit markets. These disruptions have led to a precipitous decline in sub-prime lending, a significant reduction in the availability of Alt-A loans, and higher interest rates on jumbo loans (see Chart 3). The tightening in mortgage credit has placed further downward pressure on home sales and home prices, a situation that now could derail the U.S. economic expansion.Sheila C. Bair, FDIC Chairman, The Case for Loan Modification (December 6, 2007). Testimony before the United States House Committee on Financial Services; see also FDIC Quarterly (2007), Vol. 1, No. 3, p. 22.
Chart 3
Residential mortgage credit quality continues to weaken, with both delinquencies and charge-offs on the rise at FDIC-insured institutions.Federal Deposit Insurance Corporation, Quarterly Banking Profile for 2007 Quarter 3.
This trend, in tandem with upward pricing of hybrid adjustable-rate mortgage (ARM) loans, falling home prices, and fewer refinancing options, underscores the urgency of finding a workable solution to current problems in the sub-prime mortgage market. Legislators, regulators, bankers, mortgage servicers, and consumer groups have been debating the merits of strategies that may help preserve home ownership, minimize foreclosures, and restore some stability to local housing markets.
On December 6, 2007, an industry-led plan was announced to help avert foreclosure for certain sub-prime homeowners who face unaffordable payments when their interest rates reset. This plan provides for a streamlined process to extend the starter rates on sub-prime ARMs for at least five years in cases where borrowers remain current on their loans but cannot refinance or afford the higher payments after reset. An important component of the industry-led plan is detailed reporting of loan modification activity. Working with the United States Treasury Department and other bank regulators, the FDIC will monitor loan modification levels and seek adjustments to the protocols if warranted.
Loss Mitigation Mediation (LMM) Program Mediation is usually a great way for a plaintiff and defendant to sit down with a neutral arbiter to hash out their differences and come to a resolution that is usually better than continued litigation. Mediation is successful in all types of disputes including personal injury cases, contract disputes and even divorces. However, in these cases, circuit court judges will readily punish a party who fails to attend mediation or who attends but fails to comply with the mediation order.
In 2009, the Florida Supreme Court forced every Florida Circuit Court (the courts in which Foreclosure Lawsuits are heard), to implement a mediation program for homeowners facing Foreclosure. This program was called the “Residential Mortgage Foreclosure Mediation” (RMFM) Program. The idea was for lenders to provide an in-person or telephonic meeting with the Homeowner/Defendant in the presence of an impartial mediator to discuss the Foreclosure Lawsuit and possible alternatives (including Loan Modification, Deed in Lieu of Foreclosure, and Short Sale).Shortcomings of the Residential Mortgage Foreclosure Mediation (RMFM) Program recognized by Panel, Fleysher Law Blog, http://fleysherlaw.com/blog/?p=105
The RMFM Program was cancelled in 2011 following widespread criticism of the program. The RMFM failed because it had no teeth, because judges were reluctant to punish the mortgage companies for failing to mediate in good faith, and because borrowers were not receiving the cooperation they needed from the banks. In short, the RMFM was a complete waste of time, not because mediation is a bad idea but because of the limited loss mitigation options and because most state court judges could not or would not enforce the program.
In 2012, the Bankruptcy Court in the Middle District of Florida implemented its own version of the failed RMFM, but unlike the state court version, it has seen a much higher success rate. One Orlando bankruptcy attorney reported a 90% success rate, with 18% of his modifications involving principal reduction. Similar programs have also been instituted by Bankruptcy courts in New York and Rhode Island.Loss Mitigation in Bankruptcy: Judge-Made Programs that Need More Support, Douglass Buckley, ABI Committee News, http://www.abiworld.org/committees/newsletters/consumer/vol10num4/loss.html
Following the lead of the Middle District, the Southern District of Florida Bankruptcy Court has initiated its own loss mitigation mediation (“LMM”) program. The LMM Program kicked off on April 1, 2013 and unlike the Middle District, the Southern District's program has more requirements for all parties and includes debtors in all chapters, not just Chapter 13. Chapter 7 debtors may use LMM to request a surrender of the property (a real surrender that provides for a transfer of title). LMM may be used by Chapter 13 debtors to request and apply for modification through mediation or surrender of any property they no longer want to own.
The Southern District's program also includes the utilization of a document processing program called the DMM Portal. Participants in the LMM program will use this secure online portal for the exchange of documents and communication. This program will help ensure that documents sent between the lender and the borrower and not lost or misplaced. Instant uploads and verification of transmissions are a hallmark of the portal.
Election to participate in the LMM program will suspend any pending motions for relief from stay (“MFR”). However, while an LMM is pending, debtors will be required to pay 31% of their gross monthly income through the Chapter 13 plan as an “adequate protection” payment. The fees a debtor will have to pay to participate in the program will typically include an $1,800 fee to their bankruptcy attorney for handling the modification through their Chapter 13 plan and an approximately $300 fee to the mediator.South Florida Bankruptcy Courts Implement Mortgage Modification Mediation Program, Fleysher Law Blog, http://fleysherlaw.com/blog/?p=666
While the bankruptcy mediation program does not guarantee a residential loan modification, it does make it much harder for a mortgage servicer to reject a modification because of the stringent requirement to act in good faith. For instance, if a servicer rejects a HAMP application, it will have to explain why. Often, a rejection is based upon a miscalculation, a misinterpretation, or an oversight. In this program, the debtor's attorney can demand that the servicer's representative explain his calculations. Often, the mistakes are found and corrected, resulting in the modification being accepted.
While mortgage modification and bankruptcy may not be the solution to all distressed mortgage problems, it will certainly provide an additional venue for homeowners in need. Applying for a modification through bankruptcy may provide relief from the dischargeable debts that are keeping the debtor from being able to make the mortgage payments and provide the lenders a guarantee that the borrower is no longer obligated by those burdens.
Streamlined modification process The adoption of this streamlined modification framework is an additional tool that servicers will now have to help avoid preventable foreclosures. This framework will not only help homeowners who receive a streamlined modification, but will also further address servicer capacity concerns by freeing up resources, helping ensure that borrowers do not fall through the cracks because servicers aren't able to get to them.Neel Kashkari, Interim Assistant Secretary of the Treasury for Financial Stability, Remarks on GSE, HOPE NOW streamlined loan modification program (November 11, 2008).