Previous loan modifications and old HELOCs face resetting to higher rates and recasting to full amortization likely leading to further loan modification.

In the heat of financial distress during the depths of the recession, many people asked their banks for unilateral loan term modifications in favor of the borrower. Ordinarily, banks would never consider such a request, but since so many borrowers were distressed, and since foreclosure would result in a loss of original capital, many lenders offered these distressed borrowers deals to keep them paying.

Borrowers thought they were getting a deal. Many enjoyed reduced payments, and since fees, charges, fines, and other garbage was clandestinely added to the loan balance, borrowers only saw the benefit and ignored the costs. So even when lenders appeared to capitulate to their borrowers, they still came out on top, as they always do.

As a rule, bankers don’t want to modify loans. Why would they? They made a loan in good faith to a borrower who promised to repay the loan in accordance with the terms of the promissory note. If the lender thought the borrower would not repay on the schedule established at origination, the lender would not have funded the loan.

Ordinarily, if a borrower is unable or unwilling to pay in accordance with the original terms, the lender would simply foreclose, get their loan money back, and loan that money to someone who will pay in accordance with the promissory note. Unfortunately, with so many borrowers underwater, lenders can’t foreclose and get their money back, so instead they modify loans to buy time until the resale value is higher than the outstanding loan balance.

Lenders recognize losses only when the loan is closed out at the sale of a property, either by short sale or auction. For lenders losing billions during the recession, the solution became obvious: deny short sales and stop foreclosing. By removing distressed inventory, lenders benefited two ways. First, they stopped recognizing losses, and second, the removal of distressed inventory from the market created a shortage of for-sale real estate causing house prices to go back up. Higher home prices restored collateral backing to the non-performing loans, so when lenders did allow a sale, they lost less money.

The remaining problem for lenders was how to get some revenue from their non-performing loans while they waited to reflate the housing bubble. Their solution was to aggressively modify loan terms to squeeze the last few drops of blood from their hapless victims.

Lenders succeeded wildly with loan modifications to troubled borrowers. The policy was so effective that loan modifications are now standard operating practice for loss mitigation at major lenders. Whenever and wherever a loan has collateral backing worth less than the outstanding balance, the borrower will be offered a loan modification — at least until the value of the collateral is worth more than the outstanding loan balance. At that point, the lender will return to their old practices of speedy foreclosure.

By Andrea Riquier, June 6, 2016

When mortgage mania was at its peak in 2005, millions of homeowners tapped the equity in their homes through home equity lines of credit. It’s now time to pay the piper. HELOCs come with 10-year grace periods, so 2015 marked 10 years after the frothiest borrowings. In March, delinquencies were up 87% compared to a year ago among 2005 second lien HELOCs – those that stand behind a mortgage on the property – data provider Black Knight said Monday.

HELOCs taken out in 2005, 2006, and 2007 make up 52% of all active lines of credit, suggesting delinquencies could remain elevated for some time, Black Knight said. There are about 850,000 2005 home equity lines, and 1.25 million each for 2006 and 2007, totaling about $192 billion in all.

To put those numbers in perspective, 250,000 HELOCs due to recast in Orange and LA Counties alone.

The silver lining is that more borrowers with 2006 credit lines have prepaid their HELOCs, possibly thanks to ultra-low interest rates in recent years. A similar pattern may continue with the 2007 vintage, Black Knight suggested. The jump in delinquencies is a reminder of how pervasive the housing bubble was, and how its effects linger in unexpected ways. In some ways, the housing market has recovered: sales of new and previously-owned homes rebounded to 6 million in April, the first time above that benchmark since the downturn. In some metro areas, prices have topped earlier highs. But there are still signs of a housing hangover. Nationally, prices remain below the 2006 high by double digits, housing starts haven’t picked up enough to satisfy demand, and nearly 7 million homeowners are still underwater.

Lenders will undoubtedly modify these loans, but realistically, lenders will go back to their previous loss mitigation procedures once prices reach the outstanding loan balance. Lenders will rescind the loan modification entitlement when prices reach the peak because they are better served by recovering their capital. Further, I believe the final resolution of loan modifications will push people out of their homes because most borrowers who got in over their heads will still be in over their heads when prices reach the peak; at that point, they will have to either pay up or get out, and most will be forced out.

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