Borrowers Find Help Only After Falling Behind on Mortgages

By Lingling Weiand James R. Hagerty
From The Wall Street Journal Online

Struggling homeowners seeking mortgage relief from their lenders say they are hearing a tough message: We can't help you unless you first fall behind on payments.

That is putting borrowers in a bind, given that defaulting on a mortgage triggers all kinds of headaches.

Consider Sharon Cooper of Lynn, Mass., who wants to sell her home. The problem: She now owes more than the house is worth, so she asked her lender to allow a "short sale" -- selling it for less than the amount due, and forgiving the rest -- to avoid foreclosure.

She says the lender, Countrywide Financial Corp., in August told her she would first need to fall two months behind on payments. So last month, she stopped paying. "I don't have any option but to stop paying," she says.

Countrywide disputes Ms. Cooper's version of events, saying in its files there isn't any reference to telling her that she needs to be two months behind. "We have been informed that Ms. Cooper is seeking to sell the home," a Countrywide spokesman said. "We continue to pursue this course as a possible satisfactory solution."

As past-due home loans keep piling up -- and some two million adjustable-rate mortgages prepare to adjust higher in the coming year -- mortgage companies are reaching out to borrowers in hopes of fending off foreclosures. On the other hand, they remain wary of cutting the interest rate, extending the term or forgiving debts, as long as borrowers are still current on their payments.

"Most companies are not giving people loan modifications until they are late on their loans," says Stephanie Porta, an Orlando, Fla., organizer for the Association of Community Organizations for Reform Now, or Acorn, a community-activist group.

Elizabeth Schomburg, senior vice president of the Family Credit Counseling Service in Chicago, says about 10% to 20% of some 1,000 families who sought help from the nonprofit agency last month were current on their mortgages and thus considered by lenders as "ineligible" for loan modification.

"In general, the mortgage company wants to see a consumer default on three separate payments before considering a loan modification," she says. The group offers credit-counseling services in more than 40 states.

Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling, says its member agencies in areas from Southern California to Texas have seen the same trend. "One counselor in Amarillo, Texas, just told me 'It seems to me they almost encourage people to fall behind in order to find help,' " Ms. Cunningham says.

Mortgage companies, on the other hand, often point to the way home loans are sold and packaged today as the key factor that complicates their efforts to help borrowers. Most mortgages are no longer owned by the companies that originated them, but are funneled into securities and sold to investors world-wide.

Serving Whom?

As a result, mortgage servicers -- who collect payments on the loans for a fee -- often define their responsibility as maximizing returns for the investors for whom they service the loans.

Mortgage servicers have to make sure they can "defend" the actions they take to help prevent foreclosures, said Steve Bailey, head of Countrywide's loan-administration division, in a recent interview. Often, he said, those investors ask: "Are they truly not able to pay?"

Still, Mr. Bailey said, "To recommend someone to not pay is a bad recommendation."

He acknowledged that Countrywide is "significantly more open" to modify loans for borrowers who have already fallen behind. The reason: If "you're current and trying to renegotiate the existing contract, that's not fair to the investor" in the mortgages.

Other servicers agree that it is more difficult, though not impossible, to rework loans while borrowers are still paying. Investors are concerned about "frivolous or dishonest claims of financial stress," Countrywide said in a statement.

Demand for modified loans is expected to grow. Fitch Ratings estimates that modified loans could account for 5% to 10% of all loans outstanding over the next 12 to 18 months. That compares with the current level of less than 2%.

In addition, the bond-rating firm says, loan modifications may be the only "viable" strategy to avoid foreclosures for as many as 50% of the subprime loans that are already in default or determined to face "a reasonably foreseeable default scenario."

In a move to respond to calls from regulators to stem foreclosures from spreading further, Countrywide, of Calabasas, Calif., the largest U.S. home-mortgage lender, late last month announced a plan to refinance or restructure as much as $16 billion in loans by the end of next year for homeowners facing higher payments because their interest rates are "resetting" to higher levels.

'Unprecedented Times'

"Unprecedented times call for unprecedented remedies," said Countrywide President and Chief Operating Officer David Sambol in a statement. That plan, which includes reaching out to still-current but at-risk borrowers, could put pressure on other lenders to follow suit.

"You don't want to give money away," says Larry Litton Jr., chief executive of Litton Loan Servicing, a Houston servicer specializing in "subprime" mortgages, held by borrowers with patchy credit histories. Still, he said, if some basic income and expense figures "indicate the borrower does have trouble keeping up, it's pretty easy to determine on a loan modification."

Litton estimates that it modified about 2,000 loans in September, including 1,500 already-defaulted loans and 500 still-current loans with rates resetting in the next three months.