From the NY Times…

Big Banks Easing Terms on Loans Deemed as Risks

As millions of Americans struggle in foreclosure with little hope of relief, big banks are going to borrowers who are not even in default and cutting their debt or easing the mortgage terms, sometimes with no questions asked.

Two of the nation’s biggest lenders, JPMorgan Chase and Bank of America, are quietly modifying loans for tens of thousands of borrowers who have not asked for help but whom the banks deem to be at special risk.

Rula Giosmas is one of the beneficiaries. Last year she received a letter from Chase saying it was cutting in half the amount she owed on her condominium.

Ms. Giosmas, who lives in Miami, was not in default on her $300,000 loan. She did not understand why she would receive this gift — although she wasted no time in taking it.

Banks are proactively overhauling loans for borrowers like Ms. Giosmas who have so-called pay option adjustable rate mortgages, which were popular in the wild late stages of the housing boom but which banks now view as potentially troublesome.

Before Chase shaved $150,000 off her mortgage, Ms. Giosmas owed much more on her place than it was worth. It was a fate she shared with a quarter of all homeowners with mortgages across the nation. Being underwater, as it is called, can prevent these owners from moving and taking new jobs, and places the households at greater risk of foreclosure.

Hmmm. Now why would they do such a thing?

Karl over at the Market Ticker has some potential reasons why…

Banks Reducing Principal?

Now this is interesting….

Two of the nation’s biggest lenders, JPMorgan Chase and Bank of America, are quietly modifying loans for tens of thousands of borrowers who have not asked for help but whom the banks deem to be at special risk.

Rula Giosmas is one of the beneficiaries. Last year she received a letter from Chase saying it was cutting in half the amount she owed on her condominium.

Well, there are some potential reasons why a bank would do this.  Chief among them is that they might not be able to show they actually own the paper.  That is, they may have done something that has destroyed the security interest.  If you voluntarily refinance in such a fashion, you will have re-affirmed and given them a “do-over” on the paperwork.  Of course they don’t want you know that one potential alternative is for you to pay nothing.

“It’s a huge problem,” said the economist Sam Khater. “Reducing negative equity would spark a housing recovery.”

Bah.  “Housing recovery”?  In what way?  The root problem is that houses are too expensive.  The way to resolve this is for them to become cheaper.  Removing the leverage in the system will make them cheaper.

While many homeowners desperately need help to keep their homes and cannot get it, the borrowers getting unsolicited relief from Chase sometimes suspect a trick.

Oh there almost-certainly is a trick.  I suspect the ‘trick” is that their “loans” were in some way defective and unable to be collected or foreclosed upon, particularly in judicial states.  But if Chase reworks the loans and you sign new paperwork, well, that little problem is extinguished.

Bank of America’s chief executive, Brian T. Moynihan, told the attorneys general in April that cutting principal for current borrowers would send the wrong message to all those who have struggled to pay their bills. His counterpart at Chase, Jamie Dimon, bluntly said it was “off the table.”

It appears he lied, doesn’t it?

Option ARMs were never quite as bad as predicted, partly because the crisis pushed down interest rates so far that the resets were relatively mild.

The issue is not “resets”.  It is recasts.

When an Option ARM reaches (typically) some term of years or principal balance it is forcibly recast to a fully-amortizing loan on the original terms.

Let’s say the “Option” is to make a 2% interest payment on a $500,000 loan.  The normal interest rate is 6% and the “full term” is 30 years.  A fully-amortizing payment is $2,982.84.  But a 2% interest payment is $833.33; the rest is “capitalized”, or roughly $2,150/month.

When the loan hits the hard recast limit, whether on principal balance or time, you must then make a fully-amortizing payment on the balance over the remaining original term.

So let’s assume you have a 125% negative amortization cap.  At roughly $25,000 in negative amortization a year you can make minimum payments for about five years.

Now you have 25 years to amortize $625,000 @ 6%.  Your home is worth half of the original balance, or $250,000.  And you have a big problem, because the fully-amortizing payment on that $625,000 is $4,006.85 or 481% – nearly five times – your “option” payment!

The real screw job is that many of the people who got these $500,000 loans had gross family incomes under $100,000.  The fully-amortizing recast payment is nearly $50,000 annually! There is absolutely no chance you will be able to make that payment – default, when the recast occurs, is assured.  It is a mathematical certainty, and since your home is worth far less than the principal balance a “conventional” refinance is flatly impossible unless you happen to have $300,000+ laying around that you’re willing to part with.

Thus, the incentive for “lenders” like Chase to “modify” these loans: They know that they’re going to get screwed when the recast occurs – with certainty. If there is no reasonable way for them to get a recovery on that note that exceeds what they offer you, it’s clearly in their best interest to “fix” the loan.

They key is that this strongly suggests that you, as a borrower, in such a situation have an insane amount of leverage with the banks and investors.  Your leverage rises materially if you’re able to discern that the loan was never properly processed in the first place.

Is this “moral hazard”?  You bet.  Bigtime.  But what’s the solution?  Strategic default is in fact the proper resolution when you discern, on balance, that the debt you’ve taken on cannot be paid.  It is part of recession, it bankrupts both borrowers and lenders, and there is absolutely nothing wrong with it. If the bank discerns that you are likely to recognize this and avail yourself of this option and proactively does something that will cost it less than if you do strategic default, what’s the problem?

Leverage is a bitch in all financial transactions: It helps (a lot) when things go well, and it hurts (a lot) when they go poorly.  Choosing to use it, and all borrowing is inherently the use of leverage, comes with the risk of your economic destruction if things go poorly, either through your foolishness or simply random chance.

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