There's an article out today in the New York Times that portrays mortgage servicers in a pretty bad light. How bad? It makes them sound like those nasty credit card companies that Congress not-so-gently scolded recently through some new regulation. The Times asserts that mortgage servicers might be intentionally letting houses go into foreclosure so to collect higher delinquency and foreclosure-related fees.
Those servicers are claiming that they're simply overwhelmed and can't keep up with all of the mortgage modification requests coming in. Here's what the Times reports:
But industry insiders and legal experts say the limited capacity of mortgage companies is not the primary factor impeding the government's $75 billion program to prevent foreclosures. Instead, it is that many mortgage companies are reluctant to give strapped homeowners a break because the companies collect lucrative fees on delinquent loans.
Even when borrowers stop paying, mortgage companies that service the loans collect fees out of the proceeds when homes are ultimately sold in foreclosure. So the longer borrowers remain delinquent, the greater the opportunities for these mortgage companies to extract revenue -- fees for insurance, appraisals, title searches and legal services.
First, a note of clarity. Throughout this article the New York Times uses the term "mortgage companies" to refer to "mortgage servicers." I'm not sure why they do this, but it's probably an attempt to make for easier reading. But it's just confusing. Countrywide was a mortgage company. Few exist anymore. Now mostly banks are mortgage companies. The firms they're talking about are mortgage servicers -- those who collect the mortgage payments and follow-up with delinquent borrowers. They are paid to do that work by the banks or investors who actually own the mortgages. I'm going to use the term "servicers," because I think that's clearer.
Okay, with that technical note out of the way, a few observations about this claim. First, this is troubling, but it's different from the way credit card companies charge high fees on delinquent balances. It's worse. Credit card companies don't want their customers to go bankrupt -- they want them to be delinquent as much as possible, but never actually reach the level of failure. With mortgage servicers it's different: they appear to have an incentive to see the mortgages they manage fail.
Indeed, when people stop paying their mortgage, servicers aren't getting any more fees from them. Those fees are coming through the foreclosure sale itself, as the Times explains. Credit card companies want to see you struggle, but mortgage servicers want to see you fail.
It sounds to me like banks need rethink the incentives in place for mortgage servicers. As it stands, they are literally paying servicers to fail. A servicer's job should be to keep a borrower from foreclosing -- especially at a time when home prices have drastically decreased. For example, a $100,000 mortgage modified with its interest rate reduced to a 3% fixed-rate for 30 years will require a monthly payment of $422. If that house is now worth 30% less in the market, resold for $70,000 at a 6% interest rate would require a $420 monthly payment. The bank is better off modifying. And those estimates don't include all of the other costs involved in foreclosing, the time it takes to sell the home or the modification incentives put in place by the government.
Admittedly, this analysis would have to be done on a case-by-case basis. In some situations banks might prefer foreclosure, in others modification. The bank should not be okay with its servicers earning more profit every time one of its borrowers enters foreclosure.
The solution is obvious: banks should restructure incentives so that servicers earn more money when they are successful in earning banks the highest return. In some cases that might mean modification, in others foreclosure. Not everyone facing foreclosure should have their mortgage modified, because many of those modification efforts will be in vain, as those borrowers will just end up foreclosing later rather than sooner. But in the cases where modification is in the bank's best interest, servicers should be rewarded for making it happen, not for preventing it.
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