Friday, June 17, 2016

Banks reeling as bubble-era HELOC delinquencies double in one year

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.

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