You’ve heard about predatory lending. Sub-prime loans were often originated by brokers and other originators whose responsibility ended when the loan was booked and sold. It was somebody else’s problem when the borrower couldn’t make the payments. These loans involved high fees and high interest rates, some of which were disguised. Much of this chicanery occurred during refinance, home equity or home improvement transactions. Sometimes the properties were appraised at values far in excess of any reasonable sales price. Sometimes the borrower’s income was fraudulently inflated without the borrower’s knowledge. Many of the worst cases combined inflated fees, inflated rates and inflated income statements. Loans underwritten in this fashion have created high delinquency and default rates, and in turn, a foreclosure crisis.

But that’s not the whole story. A bad situation has been made much worse by the way “loan servicers”, the organizations that collect payments and interact with the borrower do their job. It seems like a rather routine matter: collecting money and applying it to accounts. But the situation becomes complicated when the payments are delinquent or other problems arise. Many loan service employees seem to think that their job is to do everything possible to push the case into foreclosure. Too often this is done by breaking rules or making up new ones.

In Pennsylvania, when a residential mortgage loan (excepting FHA or VA loans) becomes two payments late, the lender sends a mandated notice telling the borrower how much is required to bring the loan current and how to obtain credit counseling for the purpose of applying for assistance from the State. When the notice expires in a little over 30 more days, the account is typically shut down and sent out to a law firm to be foreclosed. At this point, the lender will accept nothing but the full amount needed to bring the account current.

Unfortunately, too many cases end up in the foreclosure track because of servicer errors. In one case, a borrower who had always paid on time through an automatic deduction had a stroke. The deposits to the account stopped and so did the automatic withdrawals. Although the borrower lived in the mortgaged property, for some unknown reason, delinquency notices were sent to the address of the real estate broker that sold the property and were never forwarded. Because of the use of the wrong address, foreclosure was wrongly initiated and when this was discovered the foreclosure should have been terminated immediately. Instead, the foreclosure case proceeded. It was only stopped by the filing of preliminary objections by the borrower’s lawyer in court. Only then could the borrower, who was still recovering, get the attention of the loan servicers to work out an arrangement to get the loan back in good standing.

In another case, the borrowers had set up a voluntary tax escrow where the loan documents specifically stated that no escrow was required. The loan was sold and the new servicer made numerous mistakes with the escrow account, including paying school taxes twice and miscalculating the escrow payment. In frustration, the borrowers told the servicer to suspend the escrow account and began making payments of principal and interest only. The servicer accepted these payments for several months and then began returning the payments. The borrower continued to send payments and the servicer continued to return them and then foreclosed.

In many cases, loan servicers have entered into agreements with delinquent borrowers, accepted payments in accordance with these agreements and then stopped, sending the case to foreclosure. In some cases, after a court dismissed a defective foreclosure action, servicers have refused to accept payments of anything but the full amount needed to bring the account current. Others set up payment plans that call for large lump sum payments up front, making it impossible for the borrower at that stage to bring the account current. Too often, borrowers who want to bring loans current and have the means to make reasonable arrangements are unable to contact anyone with the authority to negotiate.

None of the foregoing horror stories would be likely to occur at a community-based bank where the loan servicing people and the customers know each other. Community bankers recognize that most completed foreclosures result in losses to the bank and, while many are inevitable, many are not. By outsourcing the responsibility for the lending and servicing functions to different entities, national lenders such as Countrywide, Chase and Wells Fargo (to name a few of the worst offenders) have done themselves and their borrowers immeasurable harm. The U.S. Bankruptcy Trustee in Pittsburgh is currently investigating the loan servicing practices in hundreds of cases and various national lenders and their counsel have been sanctioned by Bankruptcy Courts around the country for their questionable servicing practices.

By Cliff Tuttle ©2008

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