What Makes a Mortgage a “Bad Loan?” I’m Confused.

What makes a loan a “bad loan?”  I know there are lending practices defined as being predatory in nature that result in “bad loans,” but that’s not what I’m talking about.

According to the Center for Responsible Lending, “Predatory lending describes unfair, deceptive, or fraudulent practices of lenders during the loan origination process.”  So, when we talk about predatory loans, we’re talking about loans originated with any or all of the following being involved…

• Higher points or fees than the market is offering.
• Higher interest rates than the credit profile dictates.
• Knowingly based on a fraudulent appraisal.
• Hidden or undisclosed provisions (pre-payment penalties, rate caps, rate re-sets, etc.)
• Based solely on their future refinance with un-doable back-end debt to income ratios.
• Loans improperly made to protected groups (senior citizens, low income minorities, et al.)

Predatory loans are beyond “bad,” in my opinion, and those who are guilty of predatory lending practices should be criminally prosecuted and imprisoned… not as white collar criminals, but no differently than rapists or others who cause irreparable harm to their victims.  Taking advantage of a 75-year old woman in such a way that she ends up losing her home to foreclosure is a rape, to my way of thinking, and twenty years in a real penitentiary is getting off lightly, if you ask me.

MY QUESTION IS…

My question is, when none of those predatory practices apply to the origination of a loan, what else makes a loan a “bad loan?”  Are adjustable rate loans bad?  Assuming the borrower was told that the loan’s interest rate could go up, how often the rate could go up, and how far the rate could go up… then what’s the problem?

What about loans with introductory teaser rates?  Or loans requiring a balloon payment?  Are they necessarily “bad” in and of themselves?  Why?  As long as the borrower is told and understands what to expect, such as when the teaser rate will convert into a higher rate, what that will mean to the monthly payment, and when that will happen… why is the loan itself a “bad loan?”

Is it “sub-prime” loans that are “bad?”  Should we only be approving loans when people have 760 FICO scores?  I don’t think that’s right, personally.  There are many reasons that people have relatively lower credit scores, divorce being one of them… or maybe someone was injured and missed some payments because of being unable to work for a time.  I remember learning that my credit score was only 720 because I was using my credit card badly… or in other words, I was using it.

I used to use my Citibank American Airlines Visa for my business travel, and when I’d travel to Asia for two weeks at a time, or to London with my assistant, I could easily end up charging $20,000, which was very close to the card’s limit, and apparently that’s a bad thing to do.  It didn’t matter that when I’d return home, I’d send my client my expense report and pay off the card as soon as the check arrived… sometimes I’d pay it off twice a month… but it was still causing my FICO score to be lower than it should have been.

Countrywide and others made mortgages available to countless people who wouldn’t have been able to get them otherwise, and there are certainly a huge number of people still paying those loans back on time and as agreed.  So, was it the loans that were “bad,” or the lack of oversight and regulation as to how they were sold that was the real problem… and what should have been limited more stringently… besides the predatory practices listed above… I’m not talking about those type of things… we can all agree that those things are “bad.”

I’m asking because I can’t remember ever hearing anyone complain as a result of being approved for a mortgage… in fact, I seem to recall quite a bit of celebrating as a result of loans being approved.

Is it that we only judge a loan to be “bad” after it defaults, and because it defaults?  Assuming there are NOT predatory practices involved, is a loan “good” until it defaults and then it becomes “bad.”  And is it a “bad loan” because after it defaults we discover that the paperwork used in the foreclosure process is inadequate, missing or somehow fraudulent?  Does any of that make a loan “bad?”

This crisis saw home values drop faster than they ever had before, no one had a chance to react or get out of the way.  Consumer spending evaporated and before anyone realized it, we were on our way to losing eight million jobs, small business owners saw their incomes drop by up to a third, and it seemed like mortgage financing dried up overnight… because it did.

The reason I mention these factors is that our financial crisis and economic meltdown caused an awful lot of people to default on loans and many would never have defaulted had things gone differently… had the perfect storm been less perfect, if you will… or, if our government had handled anything competently over the last four years.

So, when their loans defaulted was it because of  “bad loans” or “bad economic circumstances?”

My wife and I, for example, took out an adjustable rate loan in 2006 when we refinanced our mortgage.  We’d always had a fixed rate mortgage, but by the summer of 2006, after Federal Reserve Chairman Greenspan had raised interest rates 17 consecutive times in an effort to cool down the economy, and the housing bubble had started to deflate as a result, we decided that it would soon be a safe time to look for a new home.

I hadn’t wanted to buy anything while prices were rising and homes were literally flying off the market often within a day or two of being listed.  We had been in our home for over 15 years and were certain to have plenty of equity even if prices fell by ten or twenty percent.  We bought it in 1990 for $340,000 but financed only $220,000, so after 15 years of payments, we only owed something like $180,000… and at the peak of the bubble, it appraised for $925,000.

I wanted to wait until things cooled down a bit to make sure that we didn’t end up overpaying during what was obviously a buying frenzy, pumped up by easy credit, incredibly low rates, and a population burned by the dot-com bubble’s demise that was now rushing to the supposed safety of residential real estate.  Houses, I was told by my real estate investing friends on more than one occasion during those years, could of course go down, but not down to zero… like Pets.com, they wanted to say… and I understood.

Anyway, in the summer of 2006, housing prices had stopped increasing and homes were staying on the market longer and longer, so we decided it was safe to start looking around.  We spoke to a realtor about what we should do to get the best price for our home and were told that kitchen remodels and some other cosmetic touches would be worth doing.  To finance the $75,000 or so in improvements, we decided to refinance our loan and take the money from the significant amount of equity we had in the property.

At the time, rates were up around eight percent for a 30-year fixed loan, so our mortgage broker suggested we take out the adjustable rate loan offered by Downey Savings, offered at a six percent rate that would be locked in for two years… after that it could adjust.  We were comfortable with the idea because we both felt that two years would allow for more than enough time to find our next home and sell ours.  Why make payments at an eight percent rate for the next two years, when we could make payments at six percent?

We also considered that if we didn’t find what we wanted, or decided not to move after all… we would simply refinance to a fixed rate loan.  Again, with plenty of equity and having owned our home for more than 15 years… there wasn’t really any appreciable risk involved.

Of course, as life would have it, our plans changed dramatically when health problems delayed our being able to look for homes, and by the following summer when we would have been ready, investors abruptly lost confidence in the ratings of residential mortgage backed securities, causing the secondary mortgage market to freeze, which started a free fall in home prices and tightening of credit that would end with the global financial crisis that we’ve all come to know so well.

We fixed up our home anyway, and looked around a bit, but never found a home we wanted to move into, at a price we thought reasonable, and when our adjustable rate loan was ready to adjust, I became nervous and wanted to refinance to a fixed rate.  We went to a Downey Savings branch and were told that we wouldn’t be able to refinance for various reasons that I didn’t really understand, except that the banker said that our home’s value had been to half of what it once was, at least.  The banker wasn’t sure of the specifics, but he was very candid, explaining that the bank wasn’t lending at that time… no matter what.

I was increasingly apprehensive as the adjustment date approached.  I’d heard the horror stories that were circulating and was sure that I’d be saddled with a higher payment than I expected with no alternative but to pay it or walk away from our home of 15 years.

And then our loan’s interest rate adjusted… going down to something like three or four percent and reducing our monthly payment significantly.  A year later it adjusted again… and again our rate went down.  At one point it was under two percent and our mortgage payment was only slightly higher than what you’d expect to pay for an expensive car.

Now, here we are some years later and our loan’s interest rate has adjusted upwards several times… it’s still not high enough to make the payment something we can’t handle, but it has doubled from its all time low.  What if it keeps going up next year and the year after… what if it reaches a point where we can’t afford it anymore, but also can’t qualify to refinance… and what if our servicer refuses to modify?  Just like the more than ten million before us, we’ll find ourselves at risk of foreclosure.

And should that situation come to pass, will our loan be at fault?  Will we then have a “bad” loan?

I’m sure our loan won’t be any different than all the rest we hear about all the time.  I’m sure MERS will have destroyed our chain of title.  I won’t be surprised when the bank’s lawyer refuses to show up with the original note.  I’m sure someone’s signature on something won’t be right and even though we live in California, I’m sure something will have been notarized in Brooklyn, New York… before I was born.

If our loan is in a securitized trust, I’m sure the date of its transfer will violate the Internal Revenue Code’s REMIC rules, and I’m confident that our servicer will have failed to comply with countless provisions found in the 600-page Pooling & Servicing Agreement (“PSA”).

None of that will surprise me, in fact I expect all of it and more to be the case.

So, will we then be correct to blame our situation on our “bad loan?”  Or, will we end up losing our home for the same fundamental reasons millions of others have… as a result of the same factors that took down Wall Street’s investment banks, forced General Motors into bankruptcy, and caused untold trillions in consumer wealth to disappear.

Will we become “irresponsible borrowers,” because we can’t repay our loan as agreed?  I knew our loan’s interest rate could adjust higher than the eight percent fixed rate alternative I was offered at the time, and there wasn’t anything predatory about our broker or lender.  Had someone told me that the loan I was agreeing to repay in 2006, would likely be the last loan for which I’d qualify, I wouldn’t have signed it.  But no one said anything like that.  No one knew what was coming the year after we refinanced.

I wasn’t gambling or thinking that home prices would always go up.  To the contrary, I knew they could also come down just as they had in 1991, right after we bought our home by the way.  All I was assuming was that the next 10 years would look something like the last 70… nothing more.  And I’d lived through bubble popping recessions  before, like the one that started in the Spring of 2000 and was made that much worse by the events of 9-11.

After that tragic day, I remembered President Bush telling the country to go shopping or take a vacation… and I remember doing exactly that.  First I went to Nordstrom, where I bought several new Tommy Bahama outfits and then a few days later we took off to Hawaii for a couple of weeks in paradise.  (Hey… when my president calls on me to take action, I take action.)

This recession, however, was nothing like that one.  This time no one went anywhere or bought anything.  This time around our bank closed the HELOC that we’d never even used… Citibank cut the credit limit on my Visa card for no apparent reason, and clients slashed budgets as they hunkered down hoping to survive the gathering storm.

I felt like I was like living through the first six black & white minutes of the Wizard of Oz and, like poor Dorothy and Toto, this time around it seemed no one was getting into their proverbial storm cellars in time.  This time around was absolutely terrifying, even without the flying monkeys.

Regardless, should our adjustable rate eventually cause us to default on our payments, will our friends and neighbors start talking behind our back, saying that we gambled and lost, as a result of our taking out one of those “bad adjustable rate loans?”  That would be ironic as I don’t even gamble when in Las Vegas.

Of course, when my bank refuses to modify my loan, I’m going to be on-fire-angry… like the white hot intensity of a thousand suns.  And when they jerk me around, lose my paperwork nine times, treat me like a deadbeat, and make my wife cry… I’m going to be a very unpleasant person with which to communicate.  I’m not just talking about suing them… in fact, suing them will be the absolutely pleasant part of my response to what has been their typical handling of such situations.

But, having closely followed what’s happened in the courts all over this country related to foreclosures, I’ll also know that when I try to tell the judge about the robo-signer who signed the assignment of my deed of trust… or assert that my bank doesn’t know who owns my loan… or that the securitization process violated New York trust law, that he’s going to ask me what any of that has to do with my not having made any mortgage payments for the last three years.

Nevertheless, I’ll point out what investors are alleging in lawsuits I’ve read about online, and the relevance I’ve decided to attribute to a decision handed down by a Massachusetts Land Court in 2010.  I’ll highlight how the bank failed to comply with state law, explain why MERS could never hold the beneficial interest, and quote from the OCC’s Consent Orders about the “unsafe and unsound practices,” used by the bank.

In my mind at least, I’ll do all of that and more… but I’ll also know that at best, although I may succeed in delaying our eviction, we’ll be on a path to ultimately losing our home to foreclosure because no court of equity is ever going to rule that we get to keep our half a million dollar home while the investors who loaned us $300,000 gets stiffed.

It won’t matter to the judge whether Daffy Duck signed something, the notary was only 7 years old and used the wrong stamp, the bank lost an entire folder of paperwork, or the dates turned out to be wrong on every piece of paper involved.  Equity means fairness, and no judge will ever consider it fair that after defaulting on our loan, we got to keep the home for free.

These types of claims were the product of lawyers trying to throw sand into the gears of the mortgage industry’s foreclosure machine that has continued to chew up homeowners and spit them out without  consideration as to whether modification of their loans would prevent foreclosure.  And in many ways they succeeded… more loans continue to get modified and the plight of homeowners becomes more widely understood each year.  But, these arguments were never intended to produce financial windfalls for homeowners at the expense of investors.

Yes, there have been decisions in various courts that have resulted in delays of the foreclosure process, but out of the countless thousands of cases heard in our nation’s courts over the last five years, literally only a relative handful have ended by forgiving the debt owed by the homeowner while allowing that homeowner to remain in his or her home.

Litigation against a bank is never cheap, quick, easy or certain… in fact, it’s ALWAYS expensive, time consuming, difficult… and you’ll very likely lose, as the vast majority do.  Even the few that win are often appealed by the bank and overturned.  If we’ve learned anything since 2009, litigation to prevent foreclosure is no picnic, and it’s costly to do it effectively.

If someone tells you otherwise… they’re selling something.

So, if and when my turn to face foreclosure comes, I’ll also understand that not only is it a court of equity, but additionally, I’ll know that the judge doesn’t have the power to force the bank to modify my loan, even if he or she thinks that would be the fair thing to do.  The government’s program makes modification purely voluntary, and my servicer has to follow the rules set by Fannie, Freddie and other investors.

At the end of the day, loans weren’t written to be modified when not repaid, you can’t tell investors what they have to do with their investments… and no one in our government has shown any interest in changing any of that in the least.  

If this is what happens to my wife and I, it won’t be the fault of a “bad loan”… nor will I feel as if it’s my fault either… and although I might be angry at the bank for treating me poorly and not agreeing to modify my loan, the truth is… I never expected my bank to modify a loan that I was unable to repay anyway.  I wasn’t really expecting balloons and a marching band for defaulting on my loan.

I knew when I bought every car I ever owned that were I not to make the payments, someone would come and tow it away.  The idea of asking the bank who financed my car to lower my interest rate, extend the term or reduce the amount I owe… well, its never even occurred to me.

Even in my early twenties, when there were a few times that I couldn’t make my car payments, I handled it the mature and responsible way… the way everyone does… by hiding the car in my neighbor’s garage and working my butt off until I could catch up on the payments.

And although I won’t have liked the way my bank treated me on the phone, I’ll recognize that they’re probably a whole lot nicer to people whose payments are current, when they call in with questions.

How did things get this screwed up?

In the latter part of February back in 2009, a brand new President Obama, feeling the pressure of millions of Americans at risk of losing homes, spoke of a program that was going to save 3-4 million homeowners from foreclosure.  And he made it sound as if it would be easy… all we had to do was call our banks directly.  If we needed help, there’d be HUD counselors standing by to show us the way to our homes’ salvation.

He described a program that didn’t exist back then… and still doesn’t today.  The fact is that our government, after setting expectations that couldn’t be met, failed at every turn in the foreclosure crisis, so they gave $7.6 billion to the states “hardest hit,” to see what they could do to help homeowners avoid foreclosure. Three years later, roughly 6.6 billion of those “hardest hit funds” remains unspent.  It’s become painfully clear to anyone paying attention that no one has the foggiest idea what to do.

The failure to mitigate the damage caused by foreclosures has cost this country and its financial institutions an incalculable sum.  It will be decades before consumers, investors, and our society as a whole will recover from this period in our nation’s history.  And going on six years since it began, not only is the foreclosure crisis not over, but the end is not yet in sight.

However, the truth is that if homeowners are willing to gain a better understanding of their situations, if we’re willing to come to terms with the facts before us, no matter how distasteful they may be, then we can stop feeling powerless, lost in the stress of constant uncertainty, and regain control of our lives.  It’s time for each of us to chose a path that makes the best of a terrible situation, by putting us in the best possible  position going forward.

We may not be able to bring an end to the crisis nationally, but each of us can end it individually.  We can take our power back and take control of our lives.  

Will it be fair?  No, but fair is where you go to have popcorn and cotton candy… this country has never been particularly big on fairness anyway.  The Great Depression wasn’t fair to millions of Americans either, but it happened nonetheless.  Will you like it?  Maybe not, but there have been plenty of things I haven’t liked doing, but that I did anyway to improve my life in some way.

The truth is that you’ll never feel good about what has been allowed to happen to homeowners in this country since 2008, no one will.  But human beings have an incredible capacity to go on, even in the face of horrific adversity.  I had relatives that made it through the economic collapse of the Great Depression.  And I’ve known survivors of the Nazi death camps that went on to live lives filled with love, happiness and financial success.  And if they can do what they did after what they endured… then we can for sure get through this.

They say that what doesn’t kill you makes you stronger, so who knows… maybe we’ll all be even better off having learned the hard lessons of these past few years.

So, let’s get to work understanding the pros and cons of the available options when facing foreclosure.  By facing the reality of your situation, and gaining a solid understanding of the alternatives available to you, you’ll be able to choose the path that’s best for you and your family.  Then you can start working in a focused way to ensure that you get where you want to go, remembering that sometimes the way you win a tug-of-war is to let go of the rope.

So, the truth is that should my wife and I ever find that our loan has adjusted beyond our ability to repay it, and we’re facing foreclosure as a result, we’ll make sure we appraise our situation honestly, and choose the path that’s in our best interests… the path that puts us in the best possible position going forward… so we can get back to enjoying our lives together sooner rather than later.

I just thought you’d want to know my thoughts on the subject…

Mandelman out.