Why Mortgage Rescue Plans Aren't Enough

Nov. 12, 2008— -- Laura Davis started falling behind on her home loan payments about a year ago, so she turned to her mortgage company for help. Davis, 41, wanted to work out a plan that would allow her to continue paying off her mortgage so she and her two children could stay in their Colorado home.

But, despite numerous e-mails and a letter to the company, the help never came. Recently, Davis, a single mother who works as a teacher's aide, received a notice from the company: It said that if she didn't make up her missed payments by next month, she would face foreclosure.

"I just kept hoping there was something out there that would help," she said. "But, at this point, I'm ready to pack up our stuff and get out of the house."

Even as the government and major banks unveil new programs aimed at reducing the ever-growing number of American foreclosures, critics and homeowner advocates worry that there are still many homeowners who won't benefit, including those like Davis.

Kathleen Engel, a law professor at Cleveland-Marshall College of Law in Ohio, said that Davis' story isn't unusual. Many home loan companies –- specifically, mortgage servicers that are in charge of collecting payments on loans -– just haven't had the resources necessary to cope with requests for help from homeowners.

"Servicers were not geared up to deal with defaults," Engel said. "The servicer model was designed to collect payments and distribute them and manage the loans. ... They simply don't have the skill, they don't have the operational capacity, and they don't have the people power to do this. I think their call centers are overwhelmed with requests."

There are banks that devote more staff to work on foreclosure prevention efforts -– last month, JPMorgan Chase announced it was hiring 300 new loan counselors and was establishing 24 new regional counseling centers "to provide face-to-face help in areas with high delinquency rates."

But Engel said that, in some cases, mortgage servicers' failure to provide timely help in the first place sowed seeds of distrust among borrowers, making them reluctant to reach out for help today.

"Even if (servicers) are up to speed now, that doesn't change borrowers' perception of whether the servicers will help them," she said.

Loan Modifications: Investors in the Mix

Lack of manpower at and distrust of mortgage companies are just two of the obstacles facing struggling homeowners. Ira Rheingold, executive director of the National Association of Consumer Advocates, said that the new programs don't address the issue of second mortgages.

A borrower with two mortgages can't avoid foreclosure without both modifying his or her first loan and also making some sort of arrangement with whoever owns their second mortgage. According to the Center for Responsible Lending, roughly half of all subprime loans -– loans that are granted to borrowers with poor credit history and, as of late, have been among those most likely to fall into default -– are attached to second mortgages.

Critics also say that the new plans, which include programs announced this week by the Federal Housing Finance Authority and Citigroup, don't tackle the types of mortgages that are most often at risk for default: those that are owned by investors, rather than banks. While banks commonly service such mortgages, the agreements they hold with investors limit how and when they may modify the loans.

According to Guy Cecala, publisher of the trade publication Inside Mortgage Finance, 80 percent of subprime loans and 75 percent of "Alt A" loans -– loans that require less require less borrower documentation than traditional prime loans -– are packaged in securities owned by investors.

"Unless you come with something to deal with those loans and get investors to cooperate, you are not going to find any solutions," Cecala said.

In particular, some agreements don't allow for loan modification unless a borrower is already in default. In other words, borrowers who have been on time with their payments but risk missing payments down the road –- because of, for instance, an increase in the interest rate on an adjustable rate mortgage –- often have a harder time getting their loans modified.

"One of the arguments they make is we cannot modify mortgages -- we would be hurting our investors and violating the terms of agreement by modifying mortgages that are not in default because we can't anticipate that they're going to be in default," Rheingold said.

The Government's Mortgage Plan

In a press conference Tuesday, federal officials announced the government's latest program aimed at foreclosure prevention: It targets homeowners who are 90 days past due on loans that are owned or guaranteed by government-run mortgage giants Fannie Mae and Freddie Mac.

The plan, which is modeled after a foreclosure prevention program instituted by the Federal Deposit Insurance Corporation at IndyMac Bank, would let eligible homeowners modify their loans so that their monthly payments amount to no more than 38 percent of their income. The modifications could include reduced interest rates, longer loan terms or deferred payments on loan principals.

At the press conference, Federal Housing Finance Authority Director James Lockhart urged servicers of mortgage-backed securities, and investors in those securities, to use the new government program as the standard for the industry as a whole.

"Not only will this streamlined program assist borrowers, but broad acceptance and effective implementation could stabilize communities and property values," he said.

Still, some critics say that urging servicers to voluntarily adopt the government's program isn't enough. Rheingold and Engel both say they'd like to see the government implement programs that would make loan modifications mandatory.

Thanks to a string of lawsuits, the government is forcing modifications on some loans owned by investors. Last month, Bank of America, which bought Countrywide Financial Corporation earlier this year, agreed to a settlement with 11 state attorneys general to cut interest rates and principals for nearly 400,000 Countrywide customers.

The attorneys general had filed complaints against Countrywide, alleging deceptive lending practices.

Bank of America put a positive spin on the settlement.

"We are confident that, together with the attorneys general, we have developed a comprehensive program that provides more solutions than ever before to assist troubled borrowers and put them back on the path to sustained home ownership," Barbara Desoer, president of Bank of America Mortgage, Home Equity and Insurance Services, said in a statement released recently by the bank.

But how successful the settlement will be remains to be seen. The New York law firm Grais & Ellsworth is organizing a coalition of mortgage investors to contest and possibly sue Bank of America over the plan. The plan, the law firm said on its Web site, "will violate the rights of the investors in the securitizations of (Countrywide's) loans."

With reports by ABC News' Charles Herman and Dan Arnall.