WASHINGTON Companies that collect mortgage payments could earn $500 for every loan they modify to avoid default under a plan developed by the federal regulator of the nation's savings and loans.
As millions of adjustable-rate home loans approach reset dates on which monthly mortgage payments will soar, John M. Reich, director of the Office of Thrift Supervision, says his agency's plan, which would be funded from surpluses in mortgage-backed securities, could help lower the default rate for homeowners who are in good standing but face financial problems after their loans reset.
If the OTS proposal is adopted, it could help offset a worsening credit crisis as regulators and lenders confront the fallout of lax lending practices prevalent during the past decade's housing boom. The OTS oversees institutions ranging in size from big players Seattle-based Washington Mutual Inc. and Sovereign Bancorp Inc. of Philadelphia to small community banks.
Nearly 2.3 million subprime mortgages made to borrowers with weak credit are projected to reset at higher rates through the end of next year. There are fears many of those loans risk default, aggravating the nation's soaring foreclosure rate, which nearly doubled in the third quarter.
Firms that service mortgages would make loan-by-loan judgments about whether homeowners qualify for a three-year extension of low initial "teaser" mortgage rates.
Funding for the voluntary plan would come from existing surpluses in bundles of mortgages that are sold to institutional investors, Reich said.
Kurt Eggert, a law professor at Chapman University, said compensating loan servicers for modifications to loans is crucial to the plan's success.
Modification "costs them money," Eggert said. "They're just not going to do it unless they get paid."
The upside is that an effective loan modification, he added, helps limit the losses of bundled loans that have been securitized. Every loan in a mortgage-backed security that defaults or forecloses cut the security's value by $50,000.
Still, it would be tricky to decide which homeowners are legitimate candidates for loan modifications, said Joseph Mason, a Drexel University finance professor.
And many investors in complicated mortgage-backed securities may be skeptical about how much the plan might limit potential losses from troubled loans, Mason added.
The OTS proposal is more limited in scope than one from Sheila Bair, chair of the Federal Deposit Insurance Corp., who argues that mortgage-servicing companies should agree to widespread conversions of adjustable-rate loans to fixed-rate loans for homeowners who are current on mortgage payments but on the verge of resets to sharply higher rates.
Critics say Bair's idea won't work because mortgage servicing companies have a legal responsibility to modify loans only if they're confident the changes would be helpful to the homeowner and the owner of the loan. Companies can be held liable if they permit modifications that are not in the best interest of investors.
Reich said he is uncomfortable with Bair's proposal, arguing that "investors will never return to the market again" if they know that loans can be modified in bulk.