Randy and Jennifer Rimstad of Minnetonka, Minn., refinanced their mortgage in 2004 to replace a 50-year-old furnace and pay for their youngest daughter's wedding. In May, their interest rate jumped to 8.55% from 5.55%, pushing their monthly payment from $1,654.81 to $2,295.68, and the Rimstads buckled under an adjustable rate mortgage they say they didn't understand and could ill afford. Then came the collection nightmare that tacked on another $700 or so in monthly payments.
On Dec. 5, Option One Mortgage Corp., a Kansas City, Mo.-based unit of H&R Block Inc., foreclosed because the Rimstads owed more than $18,000 in late charges and attorney's fees, on top of their past-due payments. After 24 years under the same roof, the Rimstads face an uncertain future. "I don't know what will happen to us," says Randy, 57. "We don't have any place to go." Option One says it can't comment on the specific amount owed, but that it has been working with the Rimstads and will continue to "explore options toward a solution."
Millions of other families in the U.S. could soon find themselves in the same dire straits. Some $1.2 billion in adjustable mortgages will shift to higher rates in 2006 and 2007, more than half of which are to borrowers with less-than-perfect credit, or subprime borrowers, like the Rimstads. These loans already are defaulting at unprecedented rates. Lenders are in large part responsible because they sold risky and unsuitable mortgages to unsophisticated borrowers. In some cases, of course, careless borrowers shoulder some of the blame. But some say there's another force at work: aggressive servicing tactics. "Predatory servicing has attracted little attention, yet in many respects it is more vicious and the adverse consequences are more far-ranging," says Jack M. Guttentag, professor of finance emeritus at the the University of Pennsylvania's Wharton School.
Mortgage servicers collect and record monthly payments as well as manage insurance and tax payments on some $10 trillion in mortgage debt outstanding. They also manage defaults and collections when loans go bad. Critics of the industry, such as Rawle Andrews Jr., a bankruptcy attorney with Andrews & Bowe in Washington, call them "foreclosure factories."
Servicer abuse is not new. Still, regulators had hoped the industry would have cleaned up its act since 2003 when the Federal Trade Commission and the Housing & Urban Development Dept. slapped a record $40 million fine on Fairbanks Capital Corp. in one of the worst cases of predatory servicing, which involved many of its 500,000 customers. Says Kurt Eggert, a professor at Chapman University School of Law in Orange, Calif: "The FTC hoped by nailing Fairbanks it would send a message to the whole industry. It hasn't yet."
Software glitches
Any number of predatory practices, from not crediting payments to prematurely initiating foreclosure proceedings, can send struggling home buyers over the edge. "In the subprime market, it's a huge deal because they're already in a loan that is very expensive. If you live paycheck to paycheck, the penalties of delinquency sink you deeper," says Alfred Ripley, legal counsel for consumer and housing affairs at the North Carolina Justice Center in Raleigh, a nonprofit that helps low-income families statewide.
Ivy Jackson, a director at the Housing & Urban Development Dept., is bracing for a lot more consumer complaints. "The speculation is the servicers don't have enough people to handle the volumes. We're hearing that they're not set up to service [exotic] loans."
Bureaucratic snafus and software glitches are no small problem in the servicing industry. Huge errors stem from the massive turnover of ownership alone. Servicing rights for any individual mortgage are valued separately from the actual loan and are often sold repeatedly by banks and third-party servicers without customers having a clue or a choice.
Still, there is no rule that says the old servicer must transfer the entire record to the new servicer. Often borrowers aren't informed of a change, and they use their original payment coupon book and send checks to the old address. The checks usually get sent back to the borrower, while the new servicer chalks it up as a late payment, deducts a penalty from the mortgage, and marks it as underpaid. After a few months of this, the loan is recorded as delinquent. But the customer may not know anything is wrong because servicers aren't required to send a statement, and if they do, it is often incomplete. A foreclosure notice can be the first indication of any trouble. One HUD investigator says in a recent case a borrower faced foreclosure because 19 mortgage payments were missing. "The servicer found all 19 payments in what we call a miracle' because we got involved," says the investigator.
Others aren't so lucky. Consumer lawyers say the system preys on the ignorance of borrowers and creates an opportunity to add false fees and charges not authorized by law or their mortgage contract. "The subprime servicer has found the perfect class of people with spotty credit records who are less likely than others generally to stand up for themselves," says attorney Robert C. Hilliard, a partner with Hilliard & Munoz in Corpus Christi, Tex. "And they are relentless about scaring the living daylights out of these people."
Hilliard has brought four cases against West Palm Beach, Fla.-based Ocwen Financial Corp., which, with a $50 billion portfolio, is among the 10 largest subprime servicers. (Two were successful, one was dismissed, and a fourth is in early stages.) In one case, a Galveston County jury in Texas awarded Sealy Davis, a widowed grandmother who was a nurse's aide at a children's hospital, $11.5 million after finding that Ocwen committed fraud in servicing her home-equity loan. Ocwen's general counsel, Paul Koches, says an offer to cancel the entire debt and permit Davis to keep her home was rejected early on. "They were bent on a litigation strategy to play the jury sympathy card against a deep-pocket defendant," he says. The case is on appeal.
Paying on time isn't enough to protect customers from some wily servicers. A servicer might even pocket an extra payment and never credit it to a borrower. "I have audited loans where the consumer has made all payments on a timely basis, and yet the servicing company manufactured a default and, in some cases, completed a foreclosure," says Marie McDonnell, an Orleans (Mass.)-based mortgage finance analyst who specializes in the auditing of mortgage loans.
For borrowers with financial woes, the servicing maze is the most difficult to navigate. Fifty-seven-year-old Lynda Al- len, who makes $51,000 a year, says her monthly paychecks were erratic in 2002, and she fell behind. When she tried to come clean and make good with Houston's Litton Loan Servicing, she says the company billed her $33,000, including penalties, to cover four monthly mortgage payments that would have totaled $13,000 otherwise. She still pays Litton, but filed personal bankruptcy four years ago to protect the home she has lived in for the last 13 years. She fears "they'll take my home" when she emerges from bankruptcy.
Litton says it won't comment on specific loans because of privacy issues. But given the surge in defaults, the pressure is high to keep people in their homes, says Larry B. Litton Jr., chief executive of Litton Loan Servicing, which services loans worth $60 billion. "We are...trying to lower credit losses. The last thing we want to do is raise the bar and make it more expensive for borrowers to stay in their homes." Litton says the company can lose up to 50 cents on the dollar if loans go bad, and is willing to renegotiate interest rates and waive fees. "If a consumer is really motivated to keep their home, nine times out of 10 we can help that borrower stay in their home," he says.
Not all players are so generous. McDonnell says when a consumer runs into some trouble causing him or her to be late for just one payment, the default rules written into the servicer's software appear to drive the loan mercilessly toward foreclosure. "It's as if there is zero tolerance for a delinquency, so that a payment made past the grace period is recognized as a default. At that point, payments are refused," she says. McDonnell is fighting to rescind the Rimstads' loan under alleged violations of the Truth in Lending Act.
Servicers have also been known to tack on charges for insurance that isn't required or that the homeowner already has. The customer remains oblivious because he or she doesn't get a statement. Then when the mortgage payment isn't enough to cover the new policy, the entire mortgage payment gets placed in a so-called suspense account. The servicer then reports the borrower as delinquent and charges a late fee. Says Guttentag: "They should record the payment and record a deficiency in the escrow account, which they are entitled to do. But to make the payment late because they put it in the escrow account is in my view a terrible abuse."
Such may have been the case with Vanessa Gholson of Dinwiddie, Va. Her attorney, Dale Pittman, says 98 different people at Chase Home Finance tried to sort out why Chase bought flood insurance for Gholson unbeknownst to her, and then marked her delinquent and charged her late fees when her regular mortgage payment wasn't enough to cover the new policy as well. Eventually, Chase, a unit of JP-Morgan Chase & Co., refused her mortgage payments because it wanted her to pay the delinquent amounts. Next, it hired a law firm to pursue foreclosure. A Chase spokesman says the bank purchased Gholson's mortgage from another lender, and the contract indicated that she needed flood insurance. Gholson says she lives nowhere near a flood plain. After 2 1/2 years of fighting, Chase settled with Gholson in December for $25,000, including legal fees. Says Gholson, 43, who works three jobs to pay $721 a month for her $86,000 four-bedroom house: "I work too hard to let them take my house from me."
Critics argue the fundamental business dynamics of servicing inspire wrongdoing. First, consumers have no choice about who ends up as their servicer, so market forces don't push servicers to compete on quality. Also, while some banks hold servicing rights along with loans, others are sold to third-party servicers who don't have the same incentive to maintain a good relationship in order to sell such other products as a checking account or investments. Says North Carolina attorney Ripley: "It's a fixed return for that buyer, so if they want the asset to perform, they have an incentive to generate as much fee income off of each loan as possible."