The Mortgage Modification Merry-Go-Round

The majority of foreclosure cases handled by Willcutts & Habib LLC come through the referrals of other attorneys who also assist clients with foreclosure matters, but who do not themselves attempt to litigate cases involving certain abusive mortgage servicing practices. One of the more common forms of mortgage servicing abuse that we encounter on a regular basis is what I have come to label as the “Mortgage Modification Merry-Go-Round.” As the phrase denotes, many homeowners express frustration in their efforts to apply for a mortgage modification, when often it is their own bank that recommended that they pursue such a course as a means of seeking financial assistance.

In the aftermath of America’s mortgage meltdown in 2008 and government’s ensuing bailout of the country’s largest banks, various government programs were established to encourage the banks to provide financial assistance to homeowners by way of modifications to their existing mortgages. These relief programs provided that American homeowners could seek reductions in their interest rates, monthly payments and even their outstanding principal debt. This assistance to homeowners was rationalized as a form of payback to taxpayers for subsidizing the government bailout of the banking industry.

These well-intentioned mortgage relief programs, however, almost immediately turned into a new means by which the banking industry could seek to rip-off homeowners. The 2008 mortgage crises was significantly a function of the banking industry’s new business model for handling home mortgages, which was to package their mortgages into an investment product known as “mortgage-backed securities,” which the large banks then sold to investors. Under this business model, the banks made large fees and profits by selling ownership in their mortgages to investors – typically institutional investors such as pension funds. Although the investors became the new “owners” of these mortgages that were packaged together in bond-like investment products, the banks continued to service the mortgages through mortgage servicing contracts with the investors. It is principally these mortgage servicing contracts that set up the incentives for the banks to abuse homeowners who chose to pursue financial assistance through government mortgage modification relief programs.

Not surprisingly, the mortgage servicing contracts retained by the banks provided for only modest fees to collect and process monthly mortgage payments. If on the other hand a problem were to develop with any given mortgage being serviced by the bank, then the bank was in a position to charge extra fees for addressing the problem. These circumstances created an incentive for banks to create problems where none existed and/or to aggravate problems that did exist, so as to place the bank in a position to charge more fees. With such incentives in place, the banks created playbooks for their front-line employees who interfaced with customers to encourage their homeowner mortgage customers to apply for relief through various mortgage modification programs, with the intention of thereby running up servicing fees on the homeowner’s mortgage, rather than providing the intended mortgage relief to the homeowner. 

The typical playbook for running up fees on mortgage servicing contracts begins with locking the homeowner into problem from which the homeowner cannot easily escape. The bank’s interaction with the homeowner would typically begin under one of three common scenarios: (1) a late mortgage payment caused by a temporary or permanent financial hardship, such as loss of or reduction in employment; (2) a late mortgage payment due to a simple oversight; or (3) the homeowner reaching out to the bank in response to the bank advertising the availability of mortgage modification assistance. These scenarios present the opportunity for the bank to recommend to the homeowner that they begin the process of applying for a mortgage modification, in order to obtain more favorable mortgage terms.

Somewhere during the process of applying for a mortgage modification, the bank typically informs the homeowner that in order to qualify for a mortgage modification program, they need to demonstrate a certain level of financial hardship. More specifically, the homeowner is often informed that they need to be in default of their monthly mortgage payments for three months, in order to qualify for a specific relief program. Alternatively, the homeowner is instructed to make reduced monthly mortgage payment as part of trial plan towards qualifying for a mortgage modification. The bank then typically issues a formal notice that the missed payments or reduced payments have placed the homeowner in default of their mortgage obligations, placing them at risk of foreclosure. At this stage of events, it would be difficult for the majority of homeowners to get caught up on their mortgage, and they are encouraged instead by their contacts at the bank to continue in efforts to pursue a mortgage modification. The homeowner has now embarked upon the Mortgage Modification Merry-Go-Round.

The purpose of placing the homeowner in a default status with their mortgage and getting them months behind on their payment obligations is to remove options from the homeowner for curing their predicament. The default status of the loan typically prevents homeowners from pursuing alternative financing options, and homeowners typically do not set aside the amounts of their skipped or reduced payments, such as would allow them to cure the default. They are instructed instead by the bank to continue with their efforts to apply for a mortgage modification.

The profit motive for the bank to place homeowners on the Mortgage Modification Merry-Go-Round then kicks into gear. Whereas the bank as mortgage servicer makes modest income from collecting and processing monthly mortgage payments, it can make significantly enhanced income from a mortgage that is in distress. The longer the mortgage is in distress, the longer the bank can charge enhanced fees against the mortgage account. So after prodding homeowners to apply for a mortgage modification, this money-making scheme employed by banks then calls for its staff to extend the process by finding or creating defects within a homeowner’s modification application, which results in the homeowner being instructed to go back to square one and start the process over again. The key to this part of the ruse is that the bank will insist that it needs up-to-date financial information to evaluate a homeowner’s modification application. So once a defect in the application is discovered or created – for example, by the bank purportedly losing various financial documents submitted in support of an application, the financial information submitted becomes outdated, and the homeowner is instructed to begin the process again with a new application.

Ultimately, this Mortgage Modification Merry-Go-Round leads to the bank instituting a foreclosure action, and the bank’s handling of the foreclosure becomes an additional source of enhanced fees charged by the bank in its role as mortgage servicer. Sometimes the foreclosure process itself is artificially extended by the bank to extend the enhanced fees it charges for managing the foreclosure, which is sometimes accomplished by the continuing pursuit of a mortgage modification during the bank’s prosecution of the foreclosure action. In this manner the bank churns the homeowner’s mortgage account, running up unnecessary fees against the account to the detriment of both the homeowner and the investors who actually own the mortgage loan.

The endgame of this scheme is to have the homeowner’s property sold in the foreclosure process, at which point the bank receives payment for its servicing fees that it ran up, or churned, by artificially extending both the mortgage modification process and the foreclosure process. The bank receives payment of its fees from the foreclosure sale off the top, before the investor-owners of the mortgage loan recoup their investment. There is no incentive for the bank to ever conclude a successful mortgage modification, which would bring a halt to the enhanced fees that it charges against the mortgage and prevent the bank from the payday it realizes when the home is sold in foreclosure.

The homeowner suffers through the loss of their home and the enhanced debt charged against their home, and the investors who are the owners of the mortgage loan lose by the conversion of a performing mortgage to a non-performing mortgage. Also, by running up fees against the mortgage and extending the period during which the mortgage loan is not performing, the mortgage debt often grows beyond the value of the property, to the benefit of the mortgage servicer bank who is running up its fees and the detriment of the investors, who may thereby suffer a loss on their investment. 

State and federal banking regulators have properly identified such schemes as constituting abusive and unlawful banking practices and have levied substantial fines against various banks charged with being guilty of such practices. The Connecticut courts, in turn, have recognized such practices as violating various consumer protection laws, including Connecticut’s Unfair Trade Practices Act (“CUTPA”). Connecticut homeowners who have been victimized by such practices can seek damages under the provisions of CUTPA and/or assert such abuses as a defense to a foreclosure action.

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