Murky Language Puts Homes Underwater

AP Images/Don Ryan


Revelations from Bank of America whistleblowers show widespread and ongoing abuse of homeowners seeking loan modifications to avoid foreclosure. Customer service representatives were told to lie about pending modifications and were given bonuses for pushing homeowners into default. The allegations mirror continued complaints about “dual tracking,” a practice where mortgage servicers pursue foreclosure while deciding whether or not to grant a loan modification. Servicers at the five biggest banks were required to pay $25 billion in fines and agree to dozens of new guidelines to curb these abuses as part of last year’s National Mortgage Settlement. While the banks argue that they have fixed any outstanding problems, a recent report from the settlement’s oversight monitor, Joseph Smith, showed continuing violations in several key areas, though not to the degree that housing advocates claim.

This discrepancy between homeowner complaints and bank pleas of innocence can perhaps be explained by a gap in the settlement’s dual-tracking language, which mirrors other state and federal rules for servicers. The restrictions state that servicers cannot pursue foreclosure once a homeowner turns in a “completed” application for a loan modification. However, the rules do not meaningfully define “completed.” Does this mean the initial delivery of forms and financial documents? Do all documents have to be authorized by the bank? What if documents are lost? What if servicers are missing just one piece of information? It sounds wonky, but banks have exploited these ambiguities for financial gain, and it has led to people losing their homes.

Katherine Porter, a law professor at UC-Irvine and the monitor chosen by California’s Attorney General to oversee the mortgage settlement in the Golden State, has written a white paper on the problem. “The path to becoming ‘complete’ often requires dozens of back-and-forth communications between homeowners and banks,” Porter writes. “It drags on for months, creating uncertainty and frustration and putting families at risk of foreclosure.”

A typical loan-modification application includes a standard form, authorization for the release of tax returns, and documents showing evidence of income, like recent pay stubs or a profit-loss statement. Banks require financial documents from homeowners to determine what would make an affordable modified mortgage payment. If a homeowner has a straightforward financial situation, with a single employer and relatively few outside sources of income, collecting financial documents is relatively easy. But lots of people have complex income situations—second jobs, income from renters on their properties, small businesses. The more multifaceted the income sources, the more information a bank will require.

Porter’s report tells the story of “Peggy B.,” who lost her home to foreclosure last November. Peggy was in the process of collecting documents when her home was sold. The bank told her that the sale would be postponed while she complied with requests for documents, but they sold the home anyway. Porter’s office contacted the bank, and “it informed us that Peggy’s application was missing documents at the time of the sale … because her application was not complete, the bank had not violated the dual-tracking protections in the settlement.”

This is not just a problem with the mortgage-settlement standards, but virtually all dual-tracking rules on mortgage servicers. The Consumer Financial Protection Bureau’s (CFPB) servicing rules define a “completed” application as “when a bank receives all the information that the bank requires.” This puts the discretion in the hands of the bank to decide when an application is completed. CFPB states the bank must use “reasonable diligence” to obtain the documents it needs, another term with significant wiggle room.

California enacted a new “Homeowner’s Bill of Rights” this year, which bans dual tracking when an application is completed, defining that as “when the homeowner sends in all the documents required by the bank within a reasonable amount of time.” But that doesn’t fully define “reasonable,” and doesn’t account for back-and-forth on documents with missing information, or lost documents. The legislative analysis from the Homeowner’s Bill of Rights does say it would be unreasonable for banks to file a notice of foreclosure in California during the timeframe it takes for the homeowner to collect documents. But that’s not in the statutory language that banks are required to follow, and courts have not yet ruled on the matter. Additionally, banks have been accused of deliberately misplacing documents to delay the modification process. It’s unclear whether that would even violate CFPB or California dual-tracking rules.

Game-playing like this allows banks to ignore modification timelines, while technically staying within the law. Plus, continuing to pursue foreclosure means servicers can increase their profits—by endlessly delaying modifications, servicers can keep their staffs lean, reducing labor costs. And servicer compensation provides an incentive to foreclose over modifying a loan, because they can add on foreclosure fees, and because in a foreclosure sale, losses flow to the owners of the homes, rather than the servicers.

Porter has an elegant solution for this problem, which she describes as a “gap” rather than a loophole. Her proposal would provide protection from foreclosure for any homeowner who turns in the three standard documents—the application for modification, authorization to release tax returns, and “evidence of income"—as long as they respond to this request within 30 days. Servicers would have to pause their foreclosure process as they collect and verify the documents they need, and make a decision on whether to offer a modification. This would especially help homeowners with complex incomes or language barriers, who might need more time to examine and understand all the document components involved. And Porter would include restrictions on homeowners making serial modification requests and never completing the documents, just to stay out of foreclosure.

“This would give incentive to the bank to make people complete,” Porter said in an interview. If servicers could not pursue foreclosure while processing a modification request, she believes, they would act diligently to acquire all necessary documents and make a decision. That’s not currently the case; bank communications with borrowers are often sloppy and confusing, with homeowners unable to decipher the bank’s requests. Porter thinks this change in incentives would go far to clean up the process. “When banks are motivated to get people to respond to their requests, they’re really good at it. Their refinance requests are very streamlined. If the incentives were better aligned, banks would bring their expertise to the problem.” Porter includes in the white paper sample document request letters from banks to homeowners that would make things easier for understand. Banks don’t tell homeowners in a timely manner when specific documents are received and complete, or what is wrong with documents already submitted, and Porter would add a recordkeeping worksheet to the process as well.

Since California enacted the Homeowner’s Bill of Rights this January, servicers in the state, initially wary of testing the law, are pausing their foreclosure pursuits upon initiation of the modification process, and keeping them paused as homeowners complete their applications. Despite protests from banks that they could not reasonably stop foreclosures around the country for that long a period, “they’re doing it in California and the world has not ended,” Porter said. Referring to other states like Florida, where the law requires banks to start the foreclosure process over from scratch rather than “pausing,” Porter replied, “We should not let one state’s struggle with the foreclosure system define substantive protections.”

Porter believes that state and federal regulators could reopen servicing standards to define “completed” and realign incentives for banks. Officials overseeing the National Mortgage Settlement are in discussion with banks over making these changes, though because it’s a settlement rather than a court order, they must negotiate with the banks to get sign-off on the proposed new rules. The CFPB could do a technical amendment to their servicing rules to revisit the definition; they would have to go through a public comment phase and would take several months to adopt. Finally, other states could follow California’s lead, and go further, by more rigidly defining a “completed” application. Minnesota had the first chance to do this with their own Homeowner’s Bill of Rights, but they left the “completed” definition vague as well.

Without changes, banks are likely to continue to string along borrowers with relative impunity. As long as they never complete the application, the foreclosure protections for homeowners never have to kick in. This serves as a lesson for financial regulators—every word in a rule matters. Even “completed.”

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