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February 11, 2013 2:06 PM The Mortgage Servicer Industry Still Reeks of Corruption

By Ryan Cooper

One of the key parts of the great subprime housing bubble was the originate-and-distribute model. Where in ages past banks would hold on to mortgages for the duration of the loan, and thus had clear incentives to make sure borrowers were creditworthy, nowadays companies that make mortgage loans (or originators) quickly sell them to somebody else, where they can be packaged into securities and other products.

But someone still has to deal with the day-to-day busywork of the mortgage—collecting the payments, dealing with foreclosures, and the like. So the owners of the mortgage typically hire a servicer, someone who can deal with that stuff on behalf of the investors who own the loan itself. Sounds straightforward enough, right? But especially after the financial crisis cratered millions of Americans’ home values, this industry has been rotten to the bone; it has been a major factor in worsening the foreclosure crisis.

David Dayen, one of the journalists that has been following this story closest, explains in a new investigative piece just what is driving this behavior:

In general, servicers are paid through a percentage of the unpaid principal balance on a loan. This creates problems when a borrower gets into trouble and can no longer afford their payments. There are many modifications to help a borrower in such a bind, the most sustainable, successful type being direct reductions of the principal, for obvious reasons. But forgiving principal cuts directly into servicer profits by cutting the unpaid principal balance, so most servicers shy away from it. Moreover, servicers collect structured fees - such as late fees - which make it profitable to put a borrower in default and keep him there. And foreclosures don’t hurt a servicer, because they make back their money owed, along with all fees, in a foreclosure sale, even before the investors for whom they service the loan . The investors take whatever losses result from a foreclosure; the servicer makes out just fine.
This has driven the condemnable response from servicers to the crush of delinquencies after the collapse of the housing bubble. Cash incentives to modify loans through HAMP, the Obama Administration’s foreclosure mitigation program, did not outstrip servicer compensation incentives. So with the decision to modify or foreclose completely at their discretion, servicers quickly learned to game the program. They chronically “lost” borrower’s income documents to extend the default period. They prolonged trial modifications to rack up fees, and many of the fees were not in the original lending agreement. They granted modifications that folded fees into the principal of the loan, increasing the unpaid principal balance - and thus their profit - while pushing the borrower further underwater. And they trapped borrowers by denying long-sought modifications, demanding back payments, missed interest and late fees, with the threat of foreclosure as a hammer. This often forced borrowers into ineffective “private” modifications with the servicer. At worst, it generated thousands of servicer-driven foreclosures.

What can be done? New rules from the Consumer Financial Protection Bureau and other agencies are a step in the right direction, but ultimately don’t address the issue of financial incentives in favor of foreclosure. Without action on that, the execrable servicer behavior is likely to continue. Read David’s piece for a full explanation of the details.

Ryan Cooper is a National Correspondent at The Week, and a former web editor of the Washington Monthly. Find him on Twitter: @ryanlcooper

Comments

  • CalStateDisneyland on February 11, 2013 3:02 PM:

    That was an interesting blog regarding servicers of mortgages. Thank you.

  • Josef K on February 11, 2013 3:12 PM:

    Practices like this could conceivably drive otherwise sane, sensible people completely around the bend. In fact I'm mildly surprised there hasn't been an observable spike in family suicides or someone shooting up these servicer's offices. Or if there has been, that it hasn't seen wide reporting.

    That said, I agree with the underlying thesis that this entire industry has become so rotten and destructive it should be closed down wholesale. That won't happen, at least not with any acceptable speed, but one can dream right?

  • c u n d gulag on February 11, 2013 3:24 PM:

    In years long past, we had politicians who'd try to look out for the homeowners, to protect them from unscrupulous practices like this.

    Today, too many politicians are beholden to the companies that hold the the mortgage, and don't care a wit about what happens to the poor schmucks in those home.
    After all, how much did those poor schmucks contribute to that politicians last election/reelection?
    And how much for the one right around the corner?

  • Sgt. Gym Bunny on February 11, 2013 4:13 PM:

    Wow. Sounds exactly like my student loans. A kingdom for anybody who can tell me just who the hell is servicing my loans.

  • Kevin (not the famous one) on February 11, 2013 11:25 PM:

    OK, now _this_ article made my blood (nearly) boil. Thanks Ryan for pointing out how all this works.

    For the life of me, I have no idea why anybody even considers buying a house anymore. It is a scam from one end of the deal to the other and the product is nowhere near the value of the investment (I live in Oriented Strand Board California). A friend of mine is closing on a house and the "industry" managed to delay things long enough to bump his interest rate up 1/2 a point.

    And what the others have said.