An interesting discussion is going on at Mike “Mish” Shedlock’s web site on the World Savings Option ARM Mortgages that were “picked up” by Wells Fargo with the merger of Wells and Wachovia (Wachovia bought World Savings at the end of 2006). The discussion pivots on whether the World Option ARMs are a “ticking time-bomb” for Wells in the short term, or if the “10 year” recast period is going to allow Wells to weather the on-coming storm easier (or completely).

Stoking the controversy is an iStockAnalyst article which argues Wells will be OK, after it was revealed by one writer that Credit Suisse’s well-known projections for Option ARM recasts made an erroneous, blanket 5-year recast assumption. However, that writer disagrees with the iStockAnalyst conclusion that Wells is out of the woods, even though it is based on his own data!

So who is right?

Here, I will attempt to shed light on the recast portion of this argument, and hopefully clear up confusion and add to the general understanding of the subject.

The World (Savings) Option ARM differed from most other Option ARMs in the following details:

• The Option ARM had a 125% Negative Amortization cap, which meant that if you had a loan of $400,000, the actual balance with Negative Amortization could increase to $500,000. Most other Option ARMS had 110% to 115% caps, with ABC offering some to 120% and Washington Mutual having a few at 125%, but these were minimal in numbers.
• The maximum recast period could extend out to 10 years for the World Savings loans. Washington Mutual had a few loans that could also extend out to 10 years, but all other loans extended out to only 5 years.

What is most important to remember is that the 5 year and 10 year recast periods are only estimates. The periods are subject to variations based upon the index value, the start rate, and the margin offered. For a complete background on this, you can refer to a previous article I have written on the Option ARM implosion at IamFacingForeclosure.com.

For a better understand of the recast, I have calculated payment schedules for a World Savings Option ARM and an Option ARM found with most typical lenders. So as to compare apples to apples, I am using a Start Rate of 1.5%, Margin of 3.45%, and the CODI Index Value of 4.3183% for the World Loan and the MTA Index Value of 4.2187% for the generic Option ARM. The Index Month is May 2006. Amortization Caps are 125% for the World Loan and 115% for the standard loan.

As can be seen, for the first 52 months, the minimum payment schedule would remain the same. However, at month 53, the regular Option ARM would find itself recasting to the fully amortized payment, but the World Savings Option ARM would take until the 86th month to recast, far short of the 120 months that the article stated.

There are certain factors related to the recast dates that do not appear on the above payment schedule. The primary factor is that the CODI and MTA Index adjusts monthly, so each and every adjustment will affect the month that the actual recast occurred. For example, the CODI Index is now 0.8642% and the MTA Index is now 0.5442% for Oct 2009. The lower the Index, the longer the loan takes to recast, so it is likely that the loans would now approach the recast dates of 120 or 60 months. However, if the Indexes go up, then the recasts will be on track to occur quicker.

On the face of it, the articles and the Payment Schedule would tend to support the arguments that Wells Fargo will be better off with the World Option ARMS than other lenders would. However, this is NOT simply an academic exercise, so the Real World must be factored in.

Underwriting

The World Savings loan was treated differently than most other Option ARMs. That is because World was a “portfolio lender” and held these loans instead of selling them to Wall Street. This had profound implications for World underwriting.

World Savings underwrote loans using a “Make Sense” decision criteria. This underwriting allowed for most loans to be stated income, and credit scores into the upper 500’s, with mortgage lates allowed. All that needed to be done was to “document” the late with a “good” letter of explanation. Do that, and the loan was approved, no matter the issues.

The reason that World was able to embark upon their “Make Sense” underwriting was their appraisal process. Whenever the World underwriter received a loan with an appraisal from a non-World appraiser, a World appraiser would review the appraisal. Usually, this resulted in the World appraiser reducing the value of the appraisal by 10%. This gave World an “added cushion” to the loan to value and loan amount, to protect their interests. In reality, this meant that World was extending the loan offer based upon the foreclosure value of the property. How this helped World Savings is shown in the following example.

• Appraisal Value of $500,000
• 80% loan to value = $400,000
• With 125% Negative Amortization, World would loan at a 100% loan to value.
• By reducing the appraisal amount to $450,000, World would do the loan at 80% loan to value, or $360,000. Add in the 125% Negative Amortization, then World would be back at $450,000.
• The end result is that World has a 10% equity cushion in the loan (in theory).

It should be noted that most brokers knew the World Savings practice with regard to appraisals and if the loan to value was close to 80% and since the World procedure would likely result in the loan being declined, then the broker took the loan to another lender [Ed. note - or maybe they made sure they got a more favorable appraisal, first.].

A real problem with the Option ARM loan is in regard to the World Savings Fast Action Team. This was an underwriting program where an underwriter could usually make an approval without any upper management review. The teams were located throughout the state of California, and it was easy to simply take the original loan application and credit report to the underwriter, sit down and show the underwriter the paperwork, and the underwriter would tell you how to write up the loan, stated income or not, and other issues to address. Therefore, it was relatively easy to get even difficult loans approved.

(This was also the routine when going through the World Account Representative for the broker officer. It should be noted that the same was true of other Account Reps for different lenders. )

The reality is that most borrowers were approved for the Option ARM mortgages using Stated Income loans. The income was over-inflated, and as a result, the borrowers were never qualified for the loan. If they were lucky, they could only make the minimum payment and nothing greater. If they had been required to have impound accounts and make the impound payments as well, then they would have likely defaulted at a faster rate.

Summary

In the last two years, I have audited probably about 150 World Savings Option ARMs. These have mostly been from people in default, ready to lose their homes. The common characteristics of the borrowers reflect the following:

• Stated Income loans, though the borrowers were W-2 employees who were capable of providing income documentation. If the documentation had been provided, then the borrowers would have been declined for the loan.
• 80% loan to value first mortgages, with Margins of 3.25% to 3.45%.
• Three year prepayment penalties.
• Large Yield Spread Premiums paid to the brokers.
• Loans originated from 2004 to 2007, with years to go before the recast of the loan payment.
• All had no equity left in the homes. Between the drop in values and the Negative Amortization, each borrower was underwater.

Based upon my observations, the 10 year recast date in not worth considering as beneficial to Wells Fargo. What will be the determining factors with regard to whether the Option ARM is going to harm Wells earlier than the recast dates will be:

• The Index Values and how long that they will continue to stay low. Once rates increase, then the greater likelihood of recast issues.   [Ed. note - and should the economy continue to recover anytime soon, as the is the hope, the Fed will once again raise rates.  Should the Fed keep rates too low for too long (again), it would trigger inflation or dollar devaluation, which would likely force market rates higher on their own.]
• The steady increase in the monthly payments at the minimum rate will continue to erode the disposable income of the borrower each year, which will tend to undermine the ability of the borrower to make the payments, resulting in default.
• Failure of the borrowers to be able to make taxes and insurance payments each year, which will result in the lender making the payments for the borrower and then tacking the amount onto the monthly payments, further eroding the borrower’s repayment ability.
• Continuing falling property values, which will make the borrower even more underwater with the loan. Eventually, the decision will be made to consider strategic defaults for even borrowers who could make the monthly payments but no longer see the worth in doing so, since they could default, and then buy a “better” property in 3-4 years, at a much lower price.

A point that I should bring up regarding the Credit Suisse chart of Option ARM resets that is being discussed. I have been having discussions with Bill Matz of Master’s Touch Mortgage regarding this specific point. Bill is a licensed mortgage broker, real estate attorney, tax attorney, and financial planner. He is one of the few people I trust in the business.

It is the opinion of each of us that the chart has significant errors in it. Some of the errors relate to the issue of the 10 year recast periods. Other errors relate to how differing Index values will affect the recast times.

It is our conclusion that this chart has over-estimated the coming year’s recast numbers. A large part of this conclusion is based upon the number of Option ARMS that have recast or will recast prior to the five year term. Also, it does not factor in the number of defaults that have already occurred long before the recast period.

But whatever the final timing, Wells is surely not insulated, due to the many factors outlined above.

Disclaimer:  Pulatie and LFI are not attorneys and do not dispense legal advice. The purpose of LFI is to assist attorneys and homeowners in their fight.

Contributed by Rob Harrington
co-founder, LoanChex, Inc.

I basically got into the loan audit business as a means to save my properties. As a small-fish RE investor, I was able to retire in 2005, only to wake up in 2007 and find I was possibly going to lose everything. I started the same way many of you are starting–by researching the fraud in my own two WAMU loans. My Florida nightmare had begun.

A few weeks ago, after 2 and 1/2 years of pure hell, fear, misery, frustration…. (sound familiar…?) opposing counsel and whoever purported to “own my loan” failed to show up to the hearing. The hearing was to show cause as to why the Judge’s direct order to compel discovery was not followed. That is a no-no with Judges. It shows disrespect to the Judge, the court, and to justice and fairness. And my case was dismissed… for now.

As co-founder of a Mortgage Fraud Examination firm, I have talked to many of the best auditors in the country. Here is what you should consider before you spend more money towards your legal defense of your home.

1. Only get a loan audit if you are under direct supervision of a qualified foreclosure defense attorney. Your counsel will better determine the scope of work of the audit. I urge new auditors to work ONLY under Attorney supervision and NEVER directly be paid by the homeowner. The rationale behind my humble opinion is that history repeats itself. The Attorney Generals will soon be coming after the auditors as they did the loan mod types for many good reasons. Many auditors will be coming over from the loan mod business now that they are getting shut down. This industry will become “infested.”
2. Don’t buy an audit directly from an auditing firm. You may fall into the same problem that many struggling homeowners did over the last few years when hiring a loan mod company. Loan audits are very time consuming. Audits need to be exact and precise, and direct counsel to which laws are effected by breaking down the loan origination, underwriting, appraisal, closing documents, disclosures, pooling and service agreements, escrow accounts, payment histories… and the list goes on and on, ad nauseum.
3. Beware of simple TILA/RESPA software audits. They can be easily manipulated and biased if data is not entered correctly. My partner Dave is a 15-year mortgage expert who can tear a loan apart backwards and forwards. He is emphatic that you need to find fraud and serious errors to build good pleadings, effective affirmative defenses, and viable counter-suits. Additionally, focus on securitization/ownership issues and fraudulent assignments. That’s the meaty stuff! A simple TILA/RESPA is only a small fraction of the audit process, as well, the full audit cannot be performed until after full discovery. Your attorney and auditor will work better with a collaborative approach to building your proper defense. In other words, there are far better ways to ensure better results in court. A nationally prominent examiner describes a basic TILA/RESPA audit as a “band-aid on an amputation.” Spending $300 – $499 on a TILA/RESPA audit (over the internet?) will only limit the strength of your case. Your investment may be a waste of money. When it comes to YOUR case, “why bring a knife to a gun fight?”
4. Hold your attorney accountable and responsible for the audit’s content. Great attorneys win more cases than bad attorneys. Your attorney should be the key to increasing the odds of your success. Otherwise, why are you paying them to take on a losing case that they knew you would never win?
5. And your biggest question? How much? A comprehensive audit will average around $1500 to $2500. Ouch! I humanely suggest that the audit process can evolve over a long period of time and best compliments and supplements your attorneys work as your case evolves. Discovery may take a year or longer (as it did in my personal foreclosure case.) If your case gets dismissed earlier than the discovery phase, then you would never have paid the entire cost anyways with a phased-in metered approach. Your attorney should always explain the process and expense to you. More and more attorneys are starting to create creative billing systems for homeowners in today’s market. They oftentimes will take foreclosure cases with small down payments and reasonable monthly fees. If you already have been forced to stop paying your mortgage, IT MIGHT BE CHEAPER TO LITIGATE ON A MONTHLY BASIS THAN TO PAY RENT, OR A MORTGAGE PAYMENT, ON THE SAME MONTHLY BASIS. Additionally, set a flat fee for scope of work to include all work through discovery obtainment and analysis. This “caps” your high end of your legal investment so that you are not taking some crazy ride in a taxi from hell. This also helps you budget your expenses. Drastic times demand creative solutions. Demand creative payment solutions from your attorney. If they won’t, someone else will. Their ranks are growing by the day to meet the demand.

In fairness to foreclosure defense attorneys, today’s litigation defense is not as cut and dry as any of us would like to see it. Yet, case law is being made almost daily. Judges and attorneys alike are starting to see that loans made in the last ten years are a lot different than in earlier banking history. Securitization, exotic loan products, insane underwriting practices, lack of regulatory oversight, criminality, and pure greed, creates a different slant to today’s legal issues.

This is why it is crucial to hire an attorney who has been specially-trained in foreclosure defense [Editor's Note: You can find such attorneys through our site, IamFacingForeclosure.com]. This special rare breed should be an expert in contract law, real estate law, finance law and securities law, due to the overwhelmingly complex nature of this decade’s loans. Now you know WHY, in 2009, MILLIONS of (non-attorney) consumers are in foreclosure today!

By 2010, get ready for 3 more years of the exploding “Option Arms!” As lending insiders have famously stated, “Option Arms” are like neutron bombs…. kills the people but leaves the buildings standing.” Thanks guys!! See y’all in court!

So in the final analysis, hire the right attorney first–deal with the audit later!

Relax and keep the faith! I know of four foreclosure dismissals this last few weeks. The odds are tipping in your favor!

Rob Harrington
co-founder
LoanChex, Inc.
(850) 259-6422

PS – I am NOT an attorney. No information that I share should be construed as legal advice. Always consult with a qualified foreclosure defense attorney regarding your foreclosure. (I am only a ticked-off, entrepreneurial homeowner who stands for property rights, free speech, due process, justice, and fairness in the USA.)

Attention potential authors!  Please drop us a line if you think you can contribute.

Daily, in the newspapers, radio, television and the internet, articles are written about the difficulty that borrowers face in getting loan modifications.  These reports come not just from reporters, but from loan modification companies and also attorneys who are attempting to do the loan modifications.

At the same time, the Federal Government and the Obama Administration announce new programs to assist homeowners in getting loan modifications. These programs are going to solve the problems that homeowners have, and are going to save their homes. Yet, closer inspection of the program’s details raises eyebrows about if the new program will benefit homeowners. Then within a few months of implementing the program, reports come out that the programs are not working. Homeowners are not getting the needed help. Foreclosures are increasing.

Next, states like California decide to try and pass legislation to prevent homeowners from paying money upfront to loan modification companies and attorneys for assistance in dealing with the Lenders and Servicers. Then President Obama declares that homeowners should not pay for loan modifications and that their lenders and servicers are doing the modifications for free.

Who does a homeowner believe? What is the real truth? This article will attempt to shed some light on the issues. I will focus primarily upon loans that have been securitized. These are loans that have been sold to investors, unlike portfolio loans that are kept by banks and lenders. Portfolio loans can be easier to modify, if the lender is cooperative.

What type of help can be expected from the lenders and servicers?

Typically, when a borrower falls behind on a mortgage, there are few programs available to help them get current. Refinances are generally out of the question, and bankruptcy is not a viable option for most people. What can homeowners then expect from the Servicer?

• The First Program likely to be offered is a forbearance agreement. This is an agreement that “allows” a homeowner to catch up on his late payments, without really modifying the loan. The Servicer will “offer” the homeowner a choice of usually from 4 to 12 months of higher payments, to bring the loan current. These payments are generally $1,000 or more higher than the original payments, and will often at the end of the time period end up requiring a lump sum payment to get caught up. There is no attempt by the Servicer to address the root causes of the payment issues, so the positive effects of this program are dubious to say the least.A variation of this program is to have the borrower bring in a lump sum payment at the beginning of the forbearance plan, a “Good Faith Payment”. After 4 months of making regular payments, the Agreement is made to sound like if you complete 4 months of payments on time, you will have the loan modified to something that you can afford. If you can’t make the payments, then you must come in with the rest of the lump sum that is due. Almost always, you are denied for the loan modification. The reason for the denial is that you did not meet the guidelines. In reality, you have proven that you can make your regular payment, so why give you a loan modification?This offer has been quite typical of what America’s Servicing Company does.
• The Second Program you are likely to see is an actual Loan Modification. In this program, an actual Loan Modification will be offered to the homeowner. The offer, if sincere, will usually entail an interest rate reduction down to anywhere from 2-5%. It is good for a limited period of time, before the rate increases again. I have seen these programs last from 6 months, up to 5 years. Occasionally, I will see one for thirty years, but that offer will have interest rates that are 5-6% usually.What is bad about these offers is that at the end of 5 years, you are back where you started. Either you can make the monthly payment due then, or you have to seek another loan modification, or you prepare to sell or lose your home. Most lenders will make this type of offer.
• The newest offer being made by the Fannie Mae and Freddie Mac backed loans is similar to the second program. A trial period of 4 months is offered to see if you can make the new payment. At the end of the trial period, if you have made all payment in a timely manner, then the Servicer is supposed to offer you a loan modification. This program is too new to get any reliable reading on it yet. Within the next month or two, we will begin to see if the lenders will offer permanent changes.
• There is another program for loan modifications that homeowners are hoping to get. That involves a reduction in principal on the loan amount. These offers are very rare, as I will explain later.It must be noted that the Fannie Mae and Freddie Mac programs do offer loan reductions, as well as World Savings loans on occasion. Do not be fooled by these offers. They require that if you sell the home, or when you come to the end of the loan and you think that you have paid off the mortgage, you will pay back the principal reduction that was given to you at first. So it really is no reduction at all. It simply forces you to stay in your home for many, many years, with no hope of selling or moving up until your home has appreciated in value again.

I must warn homeowners that any company who says that they are doing loan modifications and getting principal reductions of any significant amount, i.e. 25% or more, and then represent that they are getting these results continuously is likely a scam. I know of no companies regularly getting such reductions. When a company claims to do so, I ask for proof, and never hear from them again.

Why Aren’t Servicers helping homeowners?

This is the question that people are asking. Occasionally, you will hear a partial answer to the question, usually like a recent New York Times article whereby the author stated that by starting foreclosure and delaying the process, the Servicer earns more fees through late payments, attorney fees and other junk fees. This is a short-sighted answer from someone who really does not understand the process. The actual reason is much more complicated.

When loans were executed, they were usually sold to investors in the process known as Securitization.  To simplify the explanation, loans were “bundled together” by the lender and placed into trusts for IRS tax purposes and then for sale to investors. The “Issuing Entity” of the Securities “sliced and diced” the loans into “tranches”. Theses tranches were sold to securities dealers who could then sell the tranches to investors, or if they desired, they could again slice and dice the tranches again into smaller pieces and have these sold to investors.

To ensure that all parties were paid monthly, a trustee was named to oversee the payments and the correct functions of all the parts and parties to the transactions.  The trustees often included US Bank, Citibank, Chase, Deutsche Bank, Lasalle Bank, Lehman, and others.

All factors related to the Securitization Process is governed by the “Pooling and Servicing Agreement” for each trust.  The Agreement covers all aspects of the transaction from the origination of the loan, to the final disbursements.  This Agreement is where the problem in negotiating loan modifications and principal reductions occur.

The Agreements all have similar language regarding loan modifications.  Paraphrased, the Agreements authorize the Master Servicer to do loan modifications when the default of a particular loan is inevitable or likely.  It is this phrase that “prevents” servicers from modifying a loan that the borrower is up to date on payments. Here is the wording of a New Century Agreement regarding defaults:

“The servicer will be required to act with respect to mortgage loans serviced by it that are in default, or as to which default is reasonably foreseeable, in accordance with procedures set forth in the servicing agreement. These procedures may, among other things, result in (i) foreclosing on the mortgage loan, (ii) accepting the deed to the related mortgaged property in lieu of foreclosure, (iii) granting the mortgagor under the mortgage loan a modification or forbearance, which may consist of waiving, modifying or varying any term of such mortgage loan.”

(including modifications that would change the mortgage interest rate, forgive the payment of principal or interest, or extend the final maturity date of such mortgage loan) or (iv) accepting payment from the borrower of an amount less than the principal balance of the mortgage loan in final satisfaction of the mortgage loan. These procedures are intended to maximize recoveries on a net present value basis on these mortgage loans.

Notice the portion that is underlined. The Servicer must act with regard to what actions will maximize the money returned to the investor and will minimize their losses.

Furthermore, the Servicers of these loans have no vested interest in doing loan modifications.  They are simply acting as “collection agencies” most of the time.  In fact, not foreclosing is in the worst interest of the Servicer. There is another section of the Agreement that must be considered:

“The servicer is required to make P&I Advances on the related Servicer Remittance Date with respect to each mortgage loan it services, subject to the servicer’s determination in its good faith business judgment that such advance would be recoverable. Such P&I Advances by the servicer are reimbursable subject to certain conditions and restrictions, and are intended to provide both sufficient funds for the payment of principal and interest to the holders of the certificates. Notwithstanding the servicer’s determination in its good faith business judgment that a P&I Advance was recoverable when made, if a P&I Advance becomes a nonrecoverable advance, the servicer will be entitled to reimbursement for that advance from any amounts in the custodial account. The Trustee, acting as successor servicer, will advance its own funds to make P&I Advances if the servicer fails to do so, subject to its own recoverability determination and as required under the trust agreement. The servicer (and the Trustee as successor servicer and any other successor servicer, if applicable) will not be obligated to make any advances of principal on any REO property. “

This is the second part of the problem. Simply stated, for each payment missed by a homeowner, the Servicer, from its own money, must “Advance” funds from its own money, to ensure that the payment stream to the Trust and Investors are kept up. They must keep advancing this money until they foreclose on the property and take back the home. At that point, they no longer need to keep the Advance on that property going, but they will still not be able to recover their own money until the property is actually sold.

To be totally blunt, it is in the best interest of the Servicer to foreclose on the property as fast as possible to stop having to make advances out of their own money. This was the true purpose of TARP, to give the servicers money so that they would have money to continue to advance funds to the Trusts, without having to trigger a gigantic foreclosure wave (this also explains why so many people are getting to live in their homes even when they are not making payments – Uncle Sam is substituting the payments for them).

At this point, another factor comes into play, “Net Present Value”.

Net Present Value

Net Present Value is a mathematical equation. Its purpose is to determine what will earn an Investor the best return for different potential investments. The equation takes the payments to be made over a period of time for different investments in different time frames and calculates what the return would be in today’s dollars. It is a methodology that compares “apples to apples” instead of “apples and oranges”. An attempt to fully explain the equation and the process of determining Net Present Value is not in the purview of this article.

When a request for a loan modification is made, the Servicer must determine what will be of most benefit to the Investor. Which of these three options will return the most income to the Investor?

• Make no modification of the loan and balance the likelihood of the homeowner being able to repay the loan against the risk and percentage of default and the potential payments in Present Dollars.
• Modify the loan and determine the payments to be made in Present Dollars.
• Foreclose on the property and after all costs and losses, determine the Present Dollars left to the Investor.

In addition to the Net Present Value Test, the Servicer will also factor into the decision as to what will get them back their “Advances” to the Trustee.

• If they don’t modify the loan and foreclose immediately, then they must continue paying the Advances.
• If they modify the loan and do not get an upfront payment of past due amounts from the homeowner, then they must wait to get back Advances as the borrower makes the “larger” payment than what was before.
• If they modify the loan at a lower payment than what is contractually required, then the Servicer must make up the difference in Advance payments, unless the Investor has agreed to the modification (this virtually never happens).
• If the Servicer forecloses, then they stop making the Advance payments and when the property is sold, they keep their Advances out of the proceeds.

As can be seen, it is certainly in the best interest of the Servicer to foreclose on the property.

Determining Net Present Value

The process for determining the Net Present Value of either not modifying the loan or else foreclosing on the property is relatively straight-forward. The calculations are not that difficult. However, when considering the Net Present Value of the Loan Modification, that is where the issues arise.

To determine the Net Present Value of the Loan Modification, the Servicer must determine exactly how much the homeowner can afford to pay. Pay too much, and the homeowner will still likely default. Pay too little, and the Investor is losing money. So the Servicer must do a Debt Ratio Analysis like when the loan was approved, except that instead of it being Stated Income and having either a 45% or 50% total Debt Ratio, the income must be totally documented and the Housing Debt Ratio must usually be 31% for Fannie Mae, and can be up to 38% for private investors. In essence, the Servicer is now going to try and correct the mistake of not properly qualifying a person when he got the loan, and with default in evidence, the Servicer will do things “right”.

To submit for a loan modification, the Servicer will require that the homeowner provide verification of all income and all debts and expenses. The income must be realistic and meet underwriting standards, no non-verifiable income allowed. The expenses must be realistic as well. If the homeowner claims that food costs are $800 per month for a family of three, then receipts had better be provided showing it is realistic and steak and lobster is not being eaten twice a week. Clothing expenses and entertainment expenses will not be accepted.

At the point that all documentation has been provided, the Servicer will then determine what modifications are necessary to get the homeowner down to a 31% Debt Ratio. (Most are going to use 31%, because it makes qualifying for a loan modification much more difficult.) The Servicer will start reducing the Interest Rate incrementally until such time as the 31% is achieved. If the lowest level of Interest Rate is reached and the 31% Debt Ratio is still not present, then the Servicer will play with reducing the principal, if it is allowed. (The minimum basis Interest Rate is 2% above the 10 Year Monthly Treasury Average, the MTA Index.)

If principal reduction is not allowed, and the homeowner cannot reach the 31% Debt Ratio at the minimum Interest Rate, then the modification will not be approved. If principal reduction is allowed, it is likely that the reduction amount will be “forgiven” only until such time as the borrower can repay the loan at which time he must pay the “forgiven” amount, or when he sells the home and then must pay the amount.

Let us assume that the borrower has been able to reach the 31% Debt Ratio Guidelines. At this point, the lender will now do the Net Present Value Test for the modification. The Servicer will factor into the Test the likelihood of the borrower defaulting even after the modification, and other various events. (This gives the Servicer the ability to manipulate the data.) The results are compared to not doing a loan modification and for foreclosing. What works out best for the Investor is what the Servicer will chose, while also considering how quickly they can get their own money back.

I previously mentioned that the Net Present Value calculation for foreclosure was relatively easy. I still hold to that statement. However, there are issues with the calculation.

For one, the Servicer is the party that determines all the factors and the values used in determining the Net Present Value. And, it is the values that are assigned to particular factors that will determine the outcome. Some factors to consider:

1. The easiest factor to manipulate will be the current value of the property. The Servicer will provide a value to the property that may or may not be realistic. This value would set the baseline for the Test.
2. How long it takes the property to sell and at what price it would sell then.
3. Condition of the property and how much it would cost to bring the property back up to resale shape.
4. Cost of foreclosing.
5. How much in Advanced Payments had been made to the Investor.
6. Sales commission.
7. Legal Costs.

Depending upon the values assigned to these and other factors by the Servicer, the decision to foreclose or not to foreclose could be easily manipulated.

It must also be remembered that the Servicer is likely to believe that this crisis will continue for many years. Foreclosures are going to continue. Unemployment is going to increase as the economy turns worse. Home values are going to continue to drop. And, as homeowners become further underwater in home values, the decision to simply walk away will become much easier. Under these circumstances, for the Investor, it would make sense for the Servicer to foreclose on every property that they could, when they could, and to salvage as much of the remaining value of the investment as possible, instead of waiting for the “inevitable” loss. One could easily compare it to the Stock Market, where you sell early, take what you can when you can, and limit your losses.

What You Can Do About It

Now that I have presented such a gloomy picture of what to expect with foreclosure, what can be done about it with the homeowner who is in trouble and looking to save his home? After all, the Servicer is not on his side, and can work the numbers so that the Net Present Value Test will indicate that foreclosure is the best option. So what is the homeowner to do?

Having seen the games that the Servicer plays time and again, trying to discourage the homeowner to such a point that he gives up and walks away, the answer is at least simple to say:

Fight Back!!!!

Don’t let the Servicers beat you into submission. They created this mess with inappropriate lending. Chances are that you should probably have been declined for the loan, but since the lender did provide you the loan, then they have to answer for it. (This may be hard for many to accept that you really did not qualify for the loan, but it is likely the truth.)

In my opinion, based upon what I have seen the past two years, the best way to fight back will be to obtain an attorney, have a true forensic audit done on your loan, and then prepare to do battle because you are going to war against the lender.

If the lenders want your home, make them pay for it. Make them realize that you will take them to court and fight them every step of the way. If you lose a round, you come back even stronger on your appeal and fight harder.

But beware. Don’t set it up in your mind that you are going to go to court and have the jury award you the home free and clean, and putative damages. It will not usually happen, and mostly because the lender has more resources and money than you have, and they can afford to drag the proceedings out until you run out of money.

Instead, your goal is to get the lender “to the table” whereby reasonable and frank discussions can occur that will lead to resolving the situation. Often, this can occur with as little action as the filing of a Restraining Order temporarily stopping the auction of your home. Sometimes, it might take sterner terms. But the goal is to use the “minimum amount of legal force necessary” to bring the lender to the table.

By following this type of action, you may be able to save your home and have an excellent modification or reduction. Does it always work? No. There are no guarantees. But, it is better than simply walking away, letting the lender have your home, and then regretting the decision for the rest of your life.

The problem is that most people, including loan modification companies and attorneys do not understand what they are fighting against.  Nor are they helped to understand the fight because of incompetent “audit” companies who do not understand this either.  LFI will attempt to shed light on this subject as we continue our series of articles.

Disclaimer:  Pulatie and LFI are not attorneys and do not dispense legal advice. The purpose of LFI is to assist attorneys and homeowners in their fight.

Attention potential contributors!  Do drop us a line if you think you have something insightful to say.

When facing foreclosure, the homeowner is always confronted with the difficult task of researching information to acquaint him or her with what to expect in the coming months. This research will include a number of different subjects covering such issues as the foreclosure process, loan modification, legal statutes, and current trends. Somewhere in the process of researching this information, the homeowner will come across the subject of forensic loan audits and TILA and RESPA. The question then becomes, “What is TILA and RESPA and how can it help me?”

TILA and RESPA are the two main pieces of Federal Legislation that govern certain processes regarding lending, and especially so in the mortgage lending arena. TILA stands for the Truth In Lending Act, and RESPA stands for the Real Estate Settlement Procedures Act. These are specific legislative acts designed to protect the borrower.

TILA is the main effort of Congress to ensure fair lending and to protect the borrower. Its purpose is to promote the informed use of consumer credit, the costs of borrowing money, the terms of the loan and other much needed information. It requires the providing of certain disclosures of relevant information for each transaction that is considered, and it provides the legal remedies for each violation of the Act.

RESPA is the “other” main effort of Congress to regulate lending. RESPA is designed to protect the borrower by ensuring (1) fair settlement proceedings through early disclosure of settlement costs, (2) the prevention of “kickbacks” and “illegal referral fees” that increase borrowing costs to the consumer, and (3) the prohibition of certain acts that increase borrowing costs.

There is much more detail to these acts, but the purpose of this article is to provide a basic understanding of the Acts and how courts and lenders are responding to various challenges. It will focus primarily on TILA, so that the reader will better understand the legal options of any TILA violation. (Most foreclosure defenses will be based upon TILA violations.)

Under TILA, when a mortgage transaction is considered, the lender must provide a borrower within three days of receiving a loan application a number of disclosures, of which the main disclosure is the Truth In Lending Disclosure. This disclosure identifies the terms of the loan, APR, Amount Financed, Finance Charge, Total Payments, and the Payment Schedule. These disclosures are to be as accurate as possible. The purpose of providing the disclosures is so that the borrower will be better able to compare loans from different lenders.

When the loan is ready to close, and you have the “final signing”, the lender is required to provide the borrower with a Final Truth In Lending Disclosure. This disclosure, along with the final settlement statement and the Right to Cancel Notice, are the key elements in foreclose defense, when arguing a TILA violation

TILA is a technical statute. This simply means that any “material violation” can invoke the remedies as provide for in the Act. The “material” violations that most frequently invoke potential remedies are:

• APR
• Finance Charge
• Amount Financed
• Total Payments
• Payment Schedule
• Right to cancel violations.

Common Remedies for violations of TILA are

• Attorneys’ fees and court costs for successful enforcement and rescission actions.
• Statutory damages, a minimum of $200 but no more that $2,000
• Actual damages
• Double the correctly calculated finance charge (but not less than $100 or more than $1,000 for individual actions).
• Rescission

For the homeowner in foreclosure trouble, the most important of the offered remedies is Rescission, and this article will pay particular attention to it. The other remedies do not offer any ability to stop a foreclosure as Rescission can, but Rescission is entirely misunderstood and is often used in the wrong situation.

Rescission is the process of legally canceling a loan. If a violation of material disclosures is severe enough, and the threshold for severity is quite low, then the borrower has the opportunity to “rescind” or “cancel” the loan. At that point, the confusion comes in.

In theory, this is the process of rescission:

1. Borrower finds violations of the TILA that offer rescission as a remedy.
2. Borrower notifies lender of rescission by letter.
3. The security interest (the Note and Deed of Trust) automatically becomes void and the lender has 20 days within which to take any and all actions necessary to reflect the termination of the security interest. The lender is obligated to return any money or property given as earnest money or down payment within those twenty days. The borrower is not liable for any finance or other charges and is entitled to recover all fees incurred in the transaction.
4. The borrower is obligated to return to the lender any money or property the borrower received as part of the credit transaction within twenty days, as their part of the rescission.
5. If the lender does not take possession of the property or money within 20 days, then the property is retained by the borrower and is held

Wow! You may get your home free and clear… at least that is what many scandalous loan modification companies and auditor firms say.

But here is the reality of rescission:

• In California, since homes are underwater and the borrowers owe more than the home is worth, they cannot tender back to the lender the money that was borrowed, so rescission is not an effective course of action in California, and for that matter, most other states as well.
• Courts have the ability to “change the order” in which rescission is tendered, meaning that the borrower must show the ability to make a valid tender, before the security interest in the loan is cancelled.
• No ability to tender the amount due means that there is no valid rescission.

In other words, rescission does not do what the homeowner probably wants the most – to remove any financial obligation connected to the house (as before they purchased it) – since the lender is only obligated to take back the original money lent, minus fees, and tear up the contract.

What to Expect when you rescind a loan

When you go to rescind a loan, you need to be aware of what will actually happen. What I write is based upon the experience of having done over 1000 audits, and working with attorneys who do attempt loan rescissions. (In this period of time, I have seen one offer of rescission, and a number of “talks” with lenders about rescission, always after a Restraining Order is granted to a homeowner trying to stop an auction. These “talks” have usually gone nowhere.)

When you and your attorney rescind a loan, here is the actual process:

1. Your attorney will usually send a “Demand Letter” to the lender. The purpose of the letter is to notify the lender that violations of the TILA have been found in your loan and you are invoking rescission rights as remedy.
2. The lender will respond in one of two ways: (a) ignore the letter altogether, or (b), send a reply where they deny that there are any violations of TILA and that they refuse to honor rescission.
3. At this point, the homeowner has only one real option left. That will be to file for a Temporary Restraining Order to stop the sale of the property, and to request a Preliminary Injunction to be granted stopping the sale on a more permanent basis, until the lawsuit that has been filed at the same time can be heard.
4. When the lawsuit is filed, and prior to the Preliminary Junction Hearing, if there is one Federal Charge alleged in the complaint, the lender will usually have the lawsuit remanded to Federal Court and away from State Court. The purpose will be to request a dismissal of all charges. They have a simple reason for doing this. The lenders know that Federal Court judges tend to be more receptive to the lender’s side and often will dismiss the case. This appears to happen more often than not. As a result, it is beneficial for lenders to have the case remanded to Federal Court.
5. If the lawsuit is not dismissed, then the Preliminary Injunction Hearing will be held. This is actually a “mini-hearing” of the case before a judge. Based upon what is presented as evidence, the judge will determine the likelihood of the homeowner prevailing at trial, and if he finds that there is a likelihood of the borrower winning the case, he grants the injunction. Once the Injunction is granted, the lender will usually begin to talk seriously with the homeowner and attorney about resolving the issue.
6. If talks do not work out, then the homeowner is going to trial. This is a process that will take months to years to reach a conclusion and will become very expensive, especially to the homeowner. (I currently have one client that has been in settlement hearings over a year, and her lawsuit began in Dec 07.)

The homeowner must understand that the lender has a very specific goal in mind during this phase of the lawsuit. The lender wants to stall the entire process, causing extensive costs to the homeowner. It is hoped that the homeowner will simply run out of money or give up and let the home be foreclosed upon, which happens quite often.

It should also be noted that Truth In Lending and RESPA lawsuits have been regularly filed since the mid 1990’s. Case Law is extensive and often contradictory. The lenders know the cases and the rulings and taper their arguments to fit those rulings. Most of the attorneys who are taking on cases do not know these cases, so many of the arguments that they make, the lenders already have the counter arguments ready.

The way to take on the lenders is to use different plans of attack, using statutes other than TILA and RESPA. The problem is that often a lender will attempt to raise the defense of Federal Preemption, whereby Federal Law takes precedent over state law.

Federal Preemption can be fought. In most states, the statutes exist to counter Federal Preemption claims. These statutes are versions of the Federal Trade Commission Act, Section 5, which identifies Unfair and Deceptive Acts and Practices (UDAP). Lenders will claim that that these are not applicable, however, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the FDIC have all at one time or another, in guidance letters, have asserted that even National Banks could be subject to such state statutes. Case law does indeed support such actions in many instances.

Conclusion

I hope that this article has provided much needed information regarding TILA/RESPA and what can be expected when one uses them to attempt rescission and then the likelihood of court action after rescission is denied and has cleared up misconceptions about the rescission process. My next article will provide information into the audit process and what a “true” audit is designed to accomplish.

Disclaimer:  Pulatie and LFI are not attorneys and do not dispense legal advice. The purpose of LFI is to assist attorneys and homeowners in their fight.