Why Servicers Foreclose When They Should Modify and Other Puzzles of Servicer Behavior: Servicer Compensation and its Consequences
Diane E. Thompson
National Consumer Law Center
October 1, 2009
This paper analyzes the complex web of financial and legal incentives that shape how servicers respond to requests for mortgage modifications. The paper notes that the interests of the people deciding whether or not to modify loans, the servicers, are not the same as the investors, and that servicers, even when they are divisions of large banks, have different interests and incentives than investors.
The paper starts with the observation that permanent modifications are not keeping pace with foreclosures and that even temporary modifications under the government's Making Home Affordable Program are a tiny fraction of the seriously delinquent loans - despite significant monetary incentives to modify loans.
The paper focuses on the distinct incentives servicers have to foreclose or modify. Servicers, unlike lenders or investors, often profit from a foreclosure and almost always lose some money from a modification. Under the existing incentive scheme, servicers generally lose the most money on the most sustainable modifications - principal reductions - but can also lose significant amounts of money from any permanent and sustainable modification.
The paper concludes that the servicers' legal and financial incentives bias servicers to foreclose instead of modify, even when investors would profit more from a modification than a foreclosure, and that the incentives further skew servicers toward temporary modifications and away from permanent, sustainable modifications, without regard to the financial interests of investors.
The paper makes several recommendations, key among them requiring a halt to the foreclosure process pending an evaluation as to whether or not a modification is financially feasible. Such a halt would preserve the interests of homeowners and investors and would encourage servicers to expedite loan modification reviews. The paper additionally recommends greater uniformity and transparency in accounting standards for modifications, so that investors can exercise more meaningful control over servicer failure to perform modifications; review of existing accounting standards that discourage permanent modifications and require individualized review; increased standardization and automation in the loan modification process; funding and standard-setting for mediation programs; regulation of default fees; mandated principal reductions as part of the HAMP waterfall; and promotion of responsible lending at origination.
Number of Pages in PDF File: 60
Keywords: mortgages, mortgage servicing, mortgage modifications, servicer compensation
Date posted: November 9, 2009