Home mortgage lending has sure changed!
In the old days, Harry Homebuyer would head down to Main Street to meet with Joe, the friendly loan officer at the Bailey Building and Loan (made famous by the Frank Capra classic “It’s A Wonderful Life”). Most likely, Harry had an account with the bank and his kids played Little League with Joe’s kids. Joe would make a decision on Harry’s loan application based on Harry’s employment income, his credit and his character. A local appraiser would assess the value of the house based upon his extensive knowledge of the area’s real estate market. He was likely a member of the Rotary Club where Joe served as treasurer.
After Harry’s loan application was approved, he would retain a local attorney to close the title and the loan, and to make sure that everything was “OK”. Harry trusted the attorney in part because they attended the same church.
Harry expected to own the home for the full 30 year term of the mortgage. In fact, he viewed the house as his nest egg, and considered that owning it free and clear was a key part of his retirement plan.
If Harry suffered some personal financial issue, he could go back to the Bailey Building and Loan and talk to Joe about skipping a payment or two, and/or modifying the mortgage to avoid foreclosure. Not that Joe was an easy touch, but at least he would listen, with respect.
The mortgage banking industry has changed in many ways since the good old days. To be sure, mortgage lenders have opened up to a wider range of borrowers and neighborhoods. But the real estate bubble of the early 1990s, caused by accelerating home prices, the entry of more home buyers and easy terms such as 100% financing, resulted in the collapse of the savings and loan industry which was taken over by the Federal Deposit Insurance Corporation.
The mortgage industry contracted for a time, and became very conservative in its loan making decisions. This in turn dampened real estate activity, and led to home price deflation. The real estate market has its cycles and this was decidedly a downturn.
At the same time, there was a consolidation of banking institutions, as national banks acquired local and regional banks. And less competition, particularly in commercial lending.
But eventually the market recovered, and credit eased once again. A home buyer could go to a mortgage broker, who would gather the necessary financial information and shop the loan application to a variety of lenders. Theoretically, this would result in the home buyer getting the best possible terms. The mortgage broker was not concerned about the home buyer’s ability to afford the home, but was interested in receiving the large fee that the ultimate lender would pay the broker for introducing the buyer.
This all worked well so long as there was a pool of qualified buyers. From 2000 to 2005, the real estate bubble began anew, and housing prices were driven up by the entry of first time home buyers into the market, the resulting resale of existing homes and the sale of newly constructed homes.
At the same time, changes in Federal regulations transformed the way that mortgage banking operated. The mortgage lenders would transfer the mortgages to other entities, which would bundle the mortgages and use them as collateral for securities that would be sold like shares of stock – the mortgage backed security. Now Joe could not tell you who held your mortgage. Most likely some trust on the other side of the country. This led to a disconnect between the borrowers and the lenders. And the holders of the mortgage backed securities could not make an accurate assessment of whether the loans in their portfolio were solid, in part because they did not get to know the borrowers or learn much about them. But the originating lenders liked this new system because they would make money in taking the loans, while avoiding the risk of default after they sold the loans in the secondary market.
There was also a big push to have the American consumer borrow, partly in the form of credit cards, and also in the way of home equity loans. Harry was encouraged to take out a second mortgage to buy an investment property or vacation home, or to invest in the stock market, or to make consumer purchases like flat screen TVs and new cars.
Up to 2005 or thereabouts, the mortgage lending industry experienced significant financial success. However, the pool of qualified home buyers was not inexhaustible, and the lenders began to lower their lending standards. And devised new ways to make the loans work for less qualified people (in order to keep the party going). One example is the 80/20 mortgage. A lender gives the buyer a loan for 80% of the purchase price. It also originates a second mortgage for the remaining 20% of the purchase price, but sells that loan to a different investor. Thus the lender would only have risk for the first 80% of the loan.
So the mortgage industry was back to lending 100% of the home’s purchase price. Any sane person would tell you that this is unwise because the borrower would have nothing to lose, maybe a few thousand dollars in closing costs. So that the borrower would be more likely to walk away from the house in the event of hard times.
Appraisers were encouraged in some cases to validate the home price to be paid by a borrower in order to “make the deal work” and keep the lenders happy. A home in Bakersfield, CA worth $155,000.00 in 2003 was valued at $300,000.00 by June 2006. Prices were appreciating rapidly and in some cases wildly.
The less qualified loan applicants were thrilled to achieve the American dream of home ownership. But these loose lending practices led to the bursting of the real estate bubble in late 2007 and early 2008. Soon enough, homebuyers learned that they could not afford their mortgages. That the low initial interest rate on the adjustable rate mortgage that they had taken out had jumped up to make their payments unaffordable. That their mortgage broker who had told them that he could refinance that mortgage in 6 months to a year to a lower, fixed rate, had disappeared. And that because of loan defaults and foreclosures over the next few years, their home was worth less than what they owed on their mortgage. Today it is estimated that more than 28% of American homes are underwater. And that more than 2% of American borrowers are in default on their mortgages, a historic high. During the period from 2007 to the first quarter of 2009, the total decline in home prices totalled $5.6 trillion.
But don’t think about going downtown to talk to Joe when you are in trouble because he cannot help you. He will tell you that your mortgage is held by ABC Bank as trustee for XYZ Trust No. 3499. And serviced by some other entity in a distant part of the country that makes a fee for collecting your mortgage payments and remitting them to ABC Bank. And once borrowers started defaulting on their loans, the servicers got real busy and it was hard for anyone to get through and talk to a real person.
At the same time, the economy was contracting, and many homeowners lost their jobs.
As a result they could not pay their mortgages.
So the lenders did what lenders have done since the inception of the mortgage banking industry – they began foreclosure proceedings. As the default rate swelled, the number of foreclosures snowballed, until the court system was overwhelmed with pending cases.
But then some things came to light which stalled the foreclosure process. In many states, foreclosing lenders must file a foreclosure lawsuit, and submit proof of the borrower’s delinquency, the balance due on the loan and other details, in the form of an affidavit based on the personal knowledge of someone employed by the lender. Based upon sufficient proof, the court would enter a foreclosure judgment, which would allow the lender to set up a sheriffs sale for the property and take possession of the property in most cases.
But Joe was not around to sign the affidavit. The holders of the mortgage backed securities weren’t really sure of the details of the defaults, but in order to proceed with foreclosure, had employees who rubber stamped affidavits without checking the details – THE ROBOSIGNERS. These individuals might sign hundreds of affidavits per day in a robot-like fashion, thus the name “robosigner”.
Eventually, someone got wise to the robosigners and brought that to the courts’ attention. When these individuals were deposed in the foreclosure proceedings, it became clear that they were not qualified to sign the affidavits. And that many foreclosure judgments which had been entered up until that point were therefore invalid. This gave an opening for borrowers to try to set aside the foreclosure judgments. And many did so with success. Many others, with less access to information and assuming that their situations were hopeless, did not even know to try.
Lawyers in many states filed class actions challenging the foreclosure process, and attorneys general in Ohio and Texas filed actions seeking to prevent lenders from foreclosing with faulty affidavits.
Ultimately, the major banking institutions self-imposed a moratorium on foreclosure activity. And many courts, such as those in New Jersey, put a hold on foreclosures for many months. In the meantime, new legal requirements for foreclosures were implemented to ensure, among other things, that any affidavit was signed by someone with actual knowledge of the facts.
A related problem for the mortgage banking industry in this crisis was the paper trail of ownership. An individual mortgage might be sold and resold several times, but the current holder of that mortgage might not have the filed or signed paperwork evidencing its ownership of that mortgage. And as a result, courts were refusing to enter foreclosure judgments for them, and in some cases, were setting aside foreclosure judgments which had been previously entered.
At the same time, faced with a tidal wave of foreclosure filings, the courts in New Jersey and in other states implemented mediation programs to provide a means for borrowers and lenders to get together and try to work out a loan modification that the borrower could afford. In this process, borrowers submit their financial information to the lender for evaluation. The court cannot force a lender to modify a loan. And it is critical that a borrower applying for a loan modification actually be employed and show an ability to pay the modified loan.
It is advisable for a borrower seeking a loan modification to retain the services of an attorney to do so. An attorney may also be able to discover grounds for contesting the foreclosure which may make the lender more likely to grant a loan modification.
Ultimately, borrowers who cannot make any kind of serious repayment proposal will lose their homes. Today, lenders are hard at work revising their procedures, and ultimately, will be able in most cases to submit correct or corrected documentation in order to complete their foreclosures. However, at the start, a home owner in distress should consult a knowledgeable and experienced attorney about options. These options may include bankruptcy, contested foreclosure, deeds in lieu of foreclosure and short sales. A detailed article about these options is posted on this website.
Copyright 2012, Charles D. Whelan III.
(Top Photo Credit: Greater Houston BPS)