Thursday, February 5, 2009

The Good, the Bad and the Ugly of Mortgage Servicing and Implications for Mortgage Modification

By Jean Braucher in Credit Slips:

It looks as if the mortgage cramdown--er, modification--legislation will be sitting around for a while, at least until the stimulus package gets through Congress. So it seems worth talking about its reference to making "payments of such modified loan directly to the holder of the claim" instead of through the Chapter 13 trustee. Although this language was still in the manager’s version of the bill (H.R. 200) as of last week, apparently discussions continue in Washington about whether this is the best policy approach.

A big reason for needing trustees in the picture is to keep track of mortgage payments, because servicers make a lot of errors. There are apparently new servicing companies that are trying to avoid the problems that have been rampant in the industry in the past—dare we hope that some good servicers are coming on line? But no doubt there are still many of the bad (careless) and the ugly (those who are deliberately charging unreasonable or illegal fees during bankruptcy). I'd be interested to hear whether anyone is seeing improvement in this industry since the new focus on its shortcomings.

As a policy matter, the argument for payment of mortgage obligations through the Chapter 13 trustee, rather than directly, is that this approach likely makes it easier for debtors to complete their plans and keep their homes without an expensive fight at the end about whether they are up to date on payments. Putting Chapter 13 trustees in charge of disbursements gives debtors the benefit of their superior record-keeping ability and understanding and their leverage with servicers because of their continuing relationships. While lawyers in areas that have not had a practice of conduit payment of regular mortgage amounts through the trustee often oppose that approach on the assumption that trustee fees will make plans infeasible, the evidence seems to be that conduit payments result in the percentage fee going down. Most trustees already top out on the compensation they are allowed by law. Lower percentage fees in conduit trusteeships may mean that most debtors do not have a problem with feasibility, although unsecured creditors may get paid less. There may be some debtors at the margin who won’t be able to afford a plan if they have to pay trustee fees, but courts could make exceptions in such cases on feasibility grounds (feasibility can cut in different directions depending on the case).

The language in the bill about direct payment raises more questions than it answers. It is at the end of a series of possible modification actions, including writing the loan principal down to value of the collateral, extending the repayment period so that it could be up to 40 years and adjusting the interest rate to the conventional mortgage rate plus a reasonable premium for risk. So it sounds as if providing for direct payment, avoiding the chapter 13 trustee, is not a requirement but an option courts can consider, perhaps to make the payment amounts affordable by eliminating the trustee fee if necessary. But we can expect litigation over this question if the bill’s language stays as is.

Conduit payment of continuing regular mortgage obligations through the Chapter 13 trustee has been on the rise in recent years. Gordon Bermant & Jean Braucher, Making Post-Petition Mortgage Payments Inside Chapter 13 Plans: Facts, Laws, Policy, 80 Am. Bankr L. J. 261 (2006). Arrearages have always been paid through the trustee. The Ninth Circuit’s recent decision in In re Lopez, 550 F.3d 1201 (9th Cir. 2008) (adopting as its own the Bankruptcy Appellate Panel decision, thus holding that a Chapter 13 debtor could make regular mortgage payments directly and not pay trustee fees on them, assuming compliance with confirmation requirements) will not necessarily change that reality even in the 9th Circuit. Chapter 13 trustees could switch their focus to feasibility as a grounds for requiring conduit payments. It wouldn’t take many confirmation challenges investigating the debtor's history of making timely payments or the servicer's record of accurately recording them to induce most debtors' lawyers to propose conduit payments. Furthermore, local rules making conduit payments the default approach, absent a contrary request, can accomplish the same thing, while still allowing some debtors to engage in special pleading for direct payment.

Better yet, a lower percentage fee on mortgage payments, enacted into law, could give trustees sufficient compensation for the services they provide without jeopardizing plan feasibility. The logic of this approach is that the larger size of mortgage payments makes a lower percentage sufficient to cover costs. This approach could be applied to all mortgage payments, modified or not.

Maybe the servicing industry will eventually clean itself up, but even if so, trustee disbursement of all mortgage payments might be good for debtors in general. There is already evidence that wage orders (so that debtors' employers pay the trustee directly) help debtors to complete Chapter 13 plans, and wage orders combined with direct payment to the mortgage claimant avoids the possibility of a slip up in making payments (absent job loss). Two distinguished bankruptcy judges, Judge Small and Judge Wedoff, have long recommended this approach. To make mortgage modification work as a way to save homes, conduit payments (as a general rule, subject to exceptions for feasibility or other special circumstances) would probably be the best policy approach.

1 comment:

  1. A Mortgage Modification is a process whereby a home owner's mortgage is modified and both the lender and homeowner are bound by the new terms of the new mortgage.

    The most common mortgage modifications are listed below:

    lowering the mortgage interest rate
    reducing the mortgage principal balance
    fixing adjustable interest rates within the mortgage
    increasing the loan term throughout the mortgage
    forgiveness of payment defaults and fees
    or any combination of the above

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