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Why the Home Loan Mod Program is Failing

Sources: Beth Young, Financial Protection Law Center, The American Bankruptcy Institute; Artwork: <a href='http://www.creditloan.com'>Loans</a> by CreditLoan.com
Sources: Beth Young, Financial Protection Law Center, The American Bankruptcy Institute; Artwork: Loans by CreditLoan.com

It's the biggest mortgage program introduced by the federal government in decades. It's the Obama administration's best hope to help homeowners avoid foreclosure and save the U.S. economy.

And it's an abject failure.

"The bottom line is this is just an unworkable system," says Andrea Young, an attorney for the Financial Protection Law Center.

It's called the Home Affordable Modification Program (HAMP), and its goals are to "support a recovery in the housing market," according to the U.S. Treasury Department, and "help up to 3 to 4 million at-risk homeowners avoid foreclosure." In HAMP's first year of operation, it spent $37 billion in taxpayer money, well over half its total $50 billion budget.

Yet the program helped just 200,000 homeowners obtain permanent modifications to their mortgages. That's about 95 percent shy of the goal.

In a nutshell, housing experts say, here's the problem: Treasury is asking companies that helped created the mortgage mess to clean it up. Meanwhile, the market incentives that caused the crash haven't changed.

"It's like having the fox guard the henhouse," Young says.

When a house goes into foreclosure, borrowers lose their home and any equity they invested. Investors lose money.

But one sector actually profits: Loan service companies. Few people outside the mortgage industry have heard of loan servicers. Which is a shame, because servicers are fascinating and tremendously powerful.

Today, the average mortgage is written by a bank or mortgage lender, which packages it together with thousands of other mortgages and sells the bundle to a trust of investors, much like a company sells shares on Wall Street.

Investors don't want to handle the messy work traditionally done by banks, like opening envelopes from homeowners, and paying insurance. So each trust hires a loan servicing company. Loan servicers keep the actual names and addresses of real, live homeowners. They are the magic cog, the place where the real world of people and houses meets the imaginary world of securitized investments.

According to a study by Diane E. Thompson, Of Counsel at the National Consumer Law Center, the servicers' biggest source of revenue is the percentage fee they charge based on the number of mortgages in the pool. The industry's advocates claim that like everybody else, servicers lose money on foreclosures.

"You have to pay so much money to rehab the property, take care of it, resell it, and you're paying people to move paperwork, and you're not collecting anything the whole time," says Dustin Hobbes, spokesman for the Mortgage Bankers Association. "There's just no financial incentive to foreclosing."

Hobbes is wrong, Thompson says. Sure, servicers lose money while a house is in foreclosure. But as soon as the house gets resold, servicers are guaranteed by law to get all that money back, even before the investors. If the mortgage gets modified, the law gives servicers no such guarantee.

That's why many servicers push homeowners into foreclosure, housing advocates say. It's why they charge high fees, like $300 to mow the lawn of a foreclosed house.

And it's why HAMP is failing. Loan servicers still believe they make more money forcing houses into foreclosure than by modifying the loan.

"They have a financial incentive to create trouble," Young says.

Members of Congress have asked Treasury officials why, as of March, the Government Accountability Office found that 800,000 homeowners received trial modifications but only 200,000 of those became permanent. One reason is that HAMP may actually perpetuate servicers' old business model.

By giving homeowners trial modifications under HAMP, servicers can inflate the number of mortgages within their investment pool, fattening their biggest source of income. The longer a homeowner remains in a trial modification, the more fees she owes the servicer, and the harder it becomes to make the trial modification permanent.

The problem is not going away. "HAMP is likely to face additional challenges going forward," the GAO found.

The Obama administration has choices to make HAMP work, housing experts say. It could enforce HAMP by requiring servicers to give modified mortgages to all qualified homeowners. Or it could scrap HAMP altogether and let bankruptcy judges clean up the mess.

"The reason HAMP isn't working is because it's not enforceable," Thompson says.