For the past few years there has been a constant barrage of negative news on loss mitigation. Neither borrowers, nor investors, nor servicers are happy with how the financial crisis has unfolded. The response is new regulations, regulators, laws and lawsuits. But so far the result has often been blame and delay. This is unfortunate because loss mitigation is most effective when implemented early. Over time borrowers give up hope due to the accumulation of back interest, deferred maintenance, uncertainty and inertia.
By now many delinquent borrowers haven’t made payments in a year or two. Though unpopular to say, at this late date most will probably never be cured—some don’t live in the house anymore, others are in nonresponsive denial, and still others are just maximizing their time in what is now free housing.
Yet there are tens of millions of current borrowers who will probably live in negative equity for years. This portends years of sizeable new loss mitigation opportunities when some of this population inevitably experiences the personal crises of death, illness, job loss and divorce. That is why the servicing industry should preemptively propose sweeping new standards to legislators and regulators which not only change how servicers perform, but also changes the behavior of mortgage security investors, borrowers and our legal system.
New mortgage notes should be written with a single set of clear terms that detail the process of handling default, because if they are all written the same, then that will remove the need for servicers, lawyers and judges to read and interpret the terms of each individual note. Just as importantly, it makes it much easier for the borrower to understand the process and their role.
The terms of handling a default must list the responsibilities and timelines of both the borrower and servicer. Timelines and processes are important because time is the enemy. Delays make successful workouts less likely, increase the mortgage investor’s loss, and harm not only the property’s value but also the entire neighborhood.
For example, the servicer must notify the borrower of default in X days, the borrower must respond with documentation of income, assets, etc., within Y days. Deadlines are given for the servicer to acknowledge receipt of documents, for the servicer to propose workout alternatives, for the borrower to select a workout, and for the workout to be implemented. If the servicer does not offer workouts that allow the borrower to keep the house (repayment plan, modification), then the servicer must state why, just as a lender provides reasons for denial on loan applications.
If no successful workout is reached, then a foreclosure sale occurs in a fairly short number of days rather than after months or years. If new mortgages do not use standard terms, then a legal penalty could be applied, such as prohibition of a deficiency judgment on the note. The loss of judgment enforcement could also be applied to servicers who do not meet their timelines, upon which the mortgage investor would likely demand restitution from the servicer.
Foreclosures with complications, such as bankruptcy, no right party contact, or if the borrower suffered from death, illness, or divorce would require judicial administration. Otherwise the foreclosure would be a statutory process. Subordinate liens would be prohibited without the senior-lien holder’s approval. And all redemption periods would be eliminated.
Such a proposal of standardization would clearly necessitate the federal government pre-empting state and local laws. Since mortgage securities are usually sold across state lines and constitute some of the largest financial transactions in the economy, perhaps the interstate commerce clause of the Constitution could be invoked. There is truth to this argument, since the bewildering variety in state and local foreclosure laws has increased the cost to service and in extreme cases has lead to mortgages being excluded from securities.
Successful loss mitigation also requires the involvement of the mortgage investor. A new law could be written that forced the transfer of servicing if minimum standards of timelines and workout rates are not met on mortgage securities. But that is not recommended. The controversial justification for such a law would be that the servicer was harming both the borrower and the economy by not performing their contractual duties.
However, mortgage investors already have the right to transfer servicing if contractual duties are not met. Yet the lack of clarity in what loss mitigation the investor supports complicates servicer decisions and leads to less aggressive principal and interest reductions. Therefore a more radical approach would be to require that whole loans in mortgage securities not meeting performance standards be sold outright, and the new owner of the mortgages could choose the servicer or subservicer. The fear of facing liquidation would create a strong incentive for security investors to clearly request more aggressive loss mitigation from their servicers.
New regulations and laws that simply dictate terms to the servicer alone will lead to unnecessary delays where the borrower or investor do not cooperate or are nonresponsive. The keys to successful new industry loss mitigation terms are that they be standardized and that they be written to bring together the servicer, borrower and investor.
Kent Willard is principal at MTG Risk, Winston-Salem, N.C.
