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Follow the money: foreclosures beat loan modifications any day…for the bank.

Sign Of The Times - Foreclosure
Creative Commons License photo credit: respres

Did you ever wonder why banks seem to approve so few loan modifications and often just foreclose instead?  For any home owner, that seems ludicrous.  Any rational person would think, “Why can’t they just fix my adjustable rate mortgage at today’s rate and keep me in my home and paying my mortgage?  Why would they want to risk having me stop making my payments and incur all those legal fees associated with a foreclosure?  Aren’t there government programs that incentivize banks to work with home owners to modify loans?”  But you are a rational person, not an insider at the bank.  It’s whole different story if you know which rock to turn over.

The cold, hard truth is banks may make more money when they foreclose on a house than when they modify its loan.  At this point, it becomes relevant to distinguish between a loan servicer and the investor that actually owns the debt.  For example, Bank of America may collect the monthly payments but not own the actual loan.  B of A is often only the servicer for an investor who coughed up the cash (or bought the mortgage backed security) for the actual loan amount.  Loan servicers (B of A in this example) may make more money when the property forecloses.  Being professional paper-pushers, they slap delinquent accounts with late fees, legal fees and other random “processing” fees.  If the home forecloses, those back fees must be paid because the servicer is pretty high on the food chain of lien holders.  If a loan is modified, often the servicer must waive those junk fees or roll them into the modification agreement.  If the fees are rolled into the loan, the servicer gets paid back over the course of 30 years as the borrower pays off their mortgage.  The servicer who is not only processing your monthly payments but also handling all your loan modification paperwork asks themselves: “Would I like all my money paid in full soon or potentially have to waive all my fees to process this modification?”  To take it a step further, if the investor agrees to modify the loan from 6% to 5% interest rate, the servicer loses money over the long run too.  These are the people processing the loan modification applications.  No wonder they “lose” so much paperwork from well-intentioned borrowers.

To answer the question “Aren’t there government programs that incentivize banks to work with home owners to modify loans?”…well yes.  The Home Affordable Program (HAMP), birthday March 2009, offers banks between $500 and $1500 to work out a loan modification with home owners.  Let’s do the math.  Thousands of dollars’ worth of junk fees waived + a reduced interest rate = let’s just say it’s more than $500 – $1500.  I’m pretty sure servicers can do that math.  (Source: HAMP Compensation Matrix, updated Nov 9, 2010).

Let’s consider the investor who is neatly tucked behind the servicer.  The servicer is out in front taking all the heat from consumers and the press because they think that servicer actually owns the loans they process payments for.  That investor isn’t stupid.  They insured the loan on the property in the first place.  (Think: AIG).  When the house forecloses, it’s very likely the investor is paid in full by their handy insurance policy.  That’s why we buy insurance, right?  Then when that house goes up for sale on the courthouse steps, that investor (or sometimes the servicer) sends out their people to “buy it back”, so it becomes a “bank-owned property”.  If there is no one else bidding on the home, they buy it back well under market value.  Then they list the property as an REO / bank-owned property and sell it.  As the owner/seller, they bank the profit.  Then…this is the gross part…if the home owner refinanced that loan at any point, the investor can also sell the borrower’s “debt forgiveness” to debt buyers for pennies on the dollar.   See: http://en.wikipedia.org/wiki/Recourse_debt They can sell the right to collect on that “shortfall” to some vultures for a couple thousand dollars that then have the right to pursue the unfortunate borrower until the day they die.  I am not being dramatic here.  There is literally no statute of limitations on how long the debt buyer (aka collection agency) has to pursue that borrower.  The debt buyer who paid $1000 for the loan then has a tremendous opportunity to make a killing trying to collect as much as they can wring out of the borrower.  The grand finale: the investor reports the re-financed loan’s shortfall to the IRS as income to the borrower.  Let’s do the math.  Insurance pay-out + profit from selling the house as a bank owned property + a little cash on the back end to peddle it to a debt buyer = let’s just say it’s more than $500 to $1500.  I’m pretty sure the investors, like their buddies on the servicing end, can do that math.

The media rages: “Why isn’t the HAMP program helping more people stay in their homes?  It’s an utter failure!  It doesn’t make sense!”  Right, it doesn’t make sense to the banks either.  Can you imagine what the government would have to pony up to compete with the profitability equation the banks enjoy when they foreclose on a house?  If people thought the TARP bailout was over the top, it would pale in comparison.

Just a few ideas about why the banks (servicers and investors) might choose to foreclose on a home rather than modify the loan.  My guess is this is just the tip of the iceberg.

Sunday Gover

Sunday represents both buyers and sellers throughout San Diego County. Experienced and dedicated, her attention to detail, creativity and focus on your service experience produce outstanding results. Sunday is a seasoned negotiator who works for not only the best price for your home but also strategizes to achieve the best contract terms possible.

About Sunday Gover

Sunday represents both buyers and sellers throughout San Diego County. Experienced and dedicated, her attention to detail, creativity and focus on your service experience produce outstanding results. Sunday is a seasoned negotiator who works for not only the best price for your home but also strategizes to achieve the best contract terms possible.

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  • Vincent

    You are so correct about what the banks are doing!!!  I
    live in Palm Beach
    County Fl. 
    Chase services my loan, Fannie Mae is the investor.  In 2009 we hired an
    attorney, and applied for a loan mod.  After making 9 payments chase
    declined the mod saying we didn’t give them all the necessary paperwork to
    complete the loan mod.  Chase received everything they requested on time
    as it was requested.  We owed on the
    house before the loan mod $229,000, and making payments for 8 years.  We
    hired a different attorney to handle our case, and made our second attempt to
    save our home by going though the process again, made our original three
    payments to qualify, and it took seven months to finally get approved by
    chase.  We received a FedX package with the loan mod agreement, singed it,
    sent it back to chase, chase signed it, sent it back to us. The terms of the
    mod was 2% for 26 years fixed for $242,753.00.  The house is worth now
    about $190,000.00.  We were okay with the terms knowing the home was under
    water because it was a trade off for the rate!  Now here comes the
    problem.  We stared getting notices in the mail stating that chase is
    going to foreclose on the home after the signed agreement, and making all the
    payments on time using our bank to auto pay the loan on time, so we can
    have a strong paper trail in case something went wrong.  We call them in
    January 2012 to question chase, what is this all about?  They replied the
    files haven’t caught up with the foreclosure department, but everything is
    okay, just stay in touch, and keep making the payments as agreed. Them we
    receive another FedX package February 14, with a new loan mod agreement with
    new terms for $243,645.00 at 4.65% for 40 years.  We called chase again to
    see what it’s about, and was told we have to accept the new loan mod with the
    terms, and if we don’t, they will foreclose on us.  We told them that we
    will not sign a new agreement, that there was a meeting of the minds with a
    signed agreement, and we will continue to make our payment as agreed, and if
    they do try to foreclose we will let the court decide what will happen. 
    The bottom line is the bank will milk the home owner as long as they can to
    keep the money coming in, and keep the foreclose process moving along at the same
    time.  So depending on the individual circumstances you are best off doing
    battle with the bank, and stay in the home as long AS YOU CAN, but seek a
    reparable attorney.
       We did contact another attorney to review both agreements, and was
    advised that first loan mod is a binding contract, and chase should honor it.

  • http://1500loan.blogspot.com/ 1500_loan

    Just came and read, this is wow! I was seek from many
    blogs, but here is the best, I love it.

  • Ken Salas

    Sunday, I just wanted to add this link for folks to check out, it clearly spells out how this whole thing shakes out for the banks…great video.

    http://www.youtube.com/watch?v=HmodOyhAV68

  • Ken Salas

    WOW!!! Sunday, you have expossed the man behind the curtain..This is absolutely what is going on in the whole “loan modification” debacle. Also, loan modifications are complicated by contract obligations of the investors that hold the notes as well. Consider many of the investors are actually central banks of foriegn nations whom expect to be paid their investment in full, the servicer has no legal right to “modify” these terms on their behalf. The point that you have made about the profitability of foreclosure over loan modification is absolutely CORRECT. In the end of the day the home owner does not matter to them at all. The silver lining in it all is that if the homeowner knows this up front and considers this situation in the same manner as the banks, then they too can leverage their situation and make it back to the housing market much sooner than they think.(remember, FHA allows foreclosures as long as it was more than 3yrs). Bottom line, homeowners need to take the emotional factors out of their decision making becuase the Banks don’t care, as you see in the post it is all about the money. Seek short-sale first, then seek legal advise beyond that to see what Legal protections you can obtain from there to motivate your next move. Again, Sunday this is an amazing post, great job!

    • SundayGover

      Ken – thank you for your comments. As you pointed out, the complexity of contract law binding principals outside the US to US debt is a big ‘ol can of worms! If an investor is, say, the “The People’s Sovereign Fund of Singapore”, no mid-level admin supervisor at B of A has much say in how that fund is repaid. The homeowner who cashed out his kids’ college accounts to stay current on his mortgage while trying to “work out” a loan modification with that lender doesn’t know international law doesn’t even allow his particular note to go unpaid. Super sad.

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