mortgage

Why won't they modify?

Tuesday, Oct. 27
Written 12 p.m. EST

WHEN WILL THEY LEARN?: The Federal Reserve issued some "written agreements" today with various financial institutions. Check out today's agreement with VisionBank of Iowa.

Under the heading "Asset Improvement," it reads: "The Bank shall not ... extend or renew any credit to ... any borrower ... who is obligated to the Bank in any manner on any extension of credit or portion thereof that has been charged off by the Bank or classified, in whole or in part, 'loss' ... as long as such credit remains uncollected."

In English: If they defaulted on their loan, don't give them a new loan.

Seriously. The bank had to be ordered not to throw good money after bad.

WHY NOT MOD?: Yesterday I answered a reader's lengthy question about what to do about an interest-only mortgage that will still be upside-down when the first rate adjustment hits in 6½ years. Eagle-eyed reader David noticed that I didn't answer all of the reader's questions.

"You did not answer your reader's question as to why the bank would prefer to foreclose on you rather than allow you to refinance at the going rate when you have been making your payments even though the mortgage is upside down. It seems as though people who have worked hard to establish excellent credit are being penalized. What is your honest spin on what is happening here?"

Honest spin. Love that phrase.

As always, I recommend that people put themselves in the other guy's position. In this case, imagine you're a banker who lent $498,000 to someone buying a $627,000 home. For 3½ years, the borrower has been paying every month on the 10-year, interest-only ARM. The monthly payments evidently are affordable because the borrower has never been late, and the payments won't change for another 6½ years. As far as you know, the borrower isn't suffering financial hardship.

If you're the banker, this is a situation that you're comfortable with. The monthly payments have been coming faithfully, and you hope they will continue.

Now the borrower comes to you and says, "The home has lost almost half its value. Now it's worth only $350,000. Even though I can afford my monthly interest-only payment of $2,905, I want you to reduce that to $1,933 a month by forgiving $148,000 of my debt and giving me a 30-year fixed-rate mortgage at a rate that's 1.75 percentage points below what I'm paying now." What would you say?

Most people would say: "A deal's a deal. You signed a contract to repay a loan. You have a job and you can afford the payments, and I expect you to repay as promised."

What if you did forgive $148,000 of debt for someone who had never been late on the monthly payments and had not suffered financial hardship? How would you explain that to your boss and bank regulators? Would you expect to keep your job?

We're talking about a 10-year, interest-only loan, so it probably wasn't securitized and it's still on the bank's books. That simplifies the decision-making. And the simplest thing is this: The bank is collecting $2,905 a month from a borrower who can afford the payments. Why reduce that to $1,933 a month just because the borrower threatens to walk away? If the borrower does walk away, you can collect late fees and then sell the property, and lend that money out at a good interest rate to someone who will pay it back.

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