The Banks View of Mortgage Modification

When homeowners are in financial distress, a logical step is to seek mortgage modification. However, as news reports show, banks have been very slow to modify mortgages. It seems—from the homeowner’s perspective, anyway—that mortgage modification is both fair and logical; why do banks resist it?

A Mortgage is a Contract

First, bear in mind that a mortgage (or any loan) is a contract. In exchange for agreeing to make such-and-such payments at such-and-such interest rate (and paying whatever points, origination costs, etc.), the bank loans someone money. The fact that the mortgage is a contract has two consequences:

• Legally, it means the bank doesn’t have to modify the loan—the existing contract or mortgage is enforceable as it.
• Morally, the prevailing sentiment is “a contract is a contract” or a “deal is a deal.” Banks are made up of bankers, and bankers are people, who can have opinions or emotional reactions; there is a strong tendency to feel that homeowners should be held to the terms of their bargain.

Consider: if property appreciated faster than expected, so the home was worth even more than hoped, would the homeowner share that windfall with the bank? In a word, no. So it’s natural for banks to feel that they should not give up their gain—what the homeowner owes them under the mortgage—for the homeowner’s benefit.

Statistically, Many Modifications Don’t Help

IF modifying mortgages reduced defaults in a significant way, then despite the above, banks would likely be more willing to grant them. But as has been widely reported, many (possibly most) people who get hardship mortgage modifications end up falling behind again. The problem is, unless the bank gives up more than it’s willing to or really needs to (see below), the modification is generally not enough to save the homeowner. If the homeowner is likely going to default anyway, why modify the  mortgage—if the bank reduces the interest rate or took a haircut on principal, all that will happen is that when the homeowner defaults, the bank will be able to sue  or otherwise go after him for less. In cases like that, the bank gives up money for no good reason.

The Home is Collateral

Remember, the home is collateral for the mortgage. If the homeowner defaults, the bank gets the home. Banks don’t want homes, of course—they’d rather get the money. And that’s particularly so in a depressed housing market, when reselling the home is apt to be difficult. But the fact that the bank has recourse to the home sets a lower limit on how much they’d be willing to modify a mortgage.

Consider: suppose a home has $300k mortgage on it, but is current worth $270k. If the bank foreclosed, it will lose 10% of its principal. However, that also means it makes no sense for a bank to offer more than a 10% principal reduction, for example, as part of any modification—since at worst, it can take a house worth $270k.

(The same logic applies to interest rate reductions and other forms of modifications: if what the bank is giving up is more than it could realize by foreclosing and selling the home, why bother?)

How an Attorney Can Help

First, a lawyer can help negotiate with the bank on your behalf—lawyers have more experience in negotiations like this than you do. Second, a lawyer can advise you as to other options you should consider, such as, for example, bankruptcy.