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Friday, December 31, 2010

Why your bank is caught in the middle on your mortgage

Common questions I hear include “Why aren’t banks lowering interest rates on existing loans to help mortgage holders who are in trouble?” “Why aren’t banks lowering the mortgage balances owed to help troubled mortgage holders?” and “Why can’t I communicate directly with a live bank employee about a mortgage on a regular basis?”

 

The reasons for these questions, and the answers to them, are results of the evolution of the mortgage system. To understand the current mortgage system, a quick review of how it developed over the last 60 years is in order. 
 
Just after the Great Depression, home mortgages were made mostly by local banks and savings and loan associations (S&Ls).  A home mortgage applicant visited a local financial institution and applied with a loan officer in person. Loan decisions were made by a loan committee comprised of loan officers who lived in the same community. After the loan was made, the borrower would make monthly payments at that same office. If they had questions regarding the loan, borrowers would call the bank or S&L and speak to an employee who likely had worked there for the past decade. (Remember George Bailey in It’s a Wonderful Life?) 
 
The mortgage business has changed considerably since the early post-Depression years. To be assured of a stable supply of money to fund mortgages, the Federal National Mortgage Association (Fannie Mae), the Government National Mortgage Association (Ginnie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac) — all government sponsored enterprises (GSEs) — were established to provide a national secondary market for conventional and government guaranteed mortgages.
 
Thereafter, local financial institutions would originate a mortgage then sell it to a GSE. The handling of that mortgage (servicing rights) also was sold to a bank, S&L or mortgage company that was often some physical distance from the mortgaged property. 
 
Over the last two decades, a majority of loans have been originated by mortgage companies, not by banks or S&Ls. The owners of those mortgages became separated from the companies that actually serviced them. During this evolution, residential mortgage rates were tied to U.S. Treasury interest rates, and home buyers and owners benefited from the lowest interest rates possible. 
 
A consequence of this process was the automation of service. For most mortgage servicing portfolios, the servicer is only entitled to a fee as low as one-eighth percent (.125%) of the loan amount per year. For a $100,000 loan, that would be about $10.46 per month.
 
Although the federal government provides some subsidy for modifications, hiring and training additional employees results in higher costs that could ultimately mean losses on the servicing portfolios.
 
An important thing to remember is that the servicing company — most often a large bank these days — doesn’t necessarily own the loan. It is owned by investors that can be a GSE (i.e. taxpayers), a (your) pension fund, or a bank. The servicer is governed by a contract committing it to certain fiduciary responsibilities and is not authorized to make decisions about key items of a mortgage loan such as the amortization, interest rate, and balance that affect the income of the mortgage owner.
 
On a much larger scale, should Fannie Mae and Freddie Mac consider lowering the balances on loans that are underwater, it will likely mean more losses to taxpayers and more capital injected by the federal government in excess of the $134 billion already administered. The ensuing national debate and controversy could have a negative effect on interest rates.
 
Once again, your local community bank is between the proverbial rock and a hard place. In institutions where customer service is a priority, community banks gladly facilitate loan applications, but they must often leave the servicing to the larger conglomerates and government-sponsored enterprises as a matter of procedure and preservation. Sometimes evolution of a process is a good thing, (e.g. lower interest rate), and other times there are consequences (e.g. automation of service). 
 
 
Contact Fred Dawson Jr., executive vice president and chief credit officer for Commerce Bank of Arizona, an Arizona based community bank specializing in serving small to mid-size businesses in Arizona. He can be reached at fdawson@commercebankaz.com or (520) 325-5200.
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