NANCE

Loan Modification Programs:
The Potential Paradox in Fair Lending

IN RESPONSE TO THE COLLAPSING HOUSING MARKE T, escalat- ing unemployment, and staggering increases in mortgage delinquency and foreclosure rates, the U.S. government created and funded substantial programs dedicated to helping homeowners stay in their homes. Although these programs have allowed more than 200,000 homeowners to initiate modification applications, 1 the possibility of an increase in fair lending issues is emerging as a result of ineffective controls as required by the Fair Housing Act, Equal Credit Opportunity Act, Fair and Accurate Credit Transaction Act and other regulations. Authors Paul Osborne and Catherine Brown explore fair lending issues and what lenders and loan servicers can do to help prevent them.

Following Sept. 11, 2001, and the subsequent passing of the USA PATRIOT Act, many banks felt compelled to focus much of their compliance efforts and resources on the prevention and detection of money laundering and terrorist financing. As a result, for many institutions fair lending took a temporary backseat to other compliance priorities. Now that the subprime and broader credit crises have once again brought fair lending risks to the forefront, many banks must re-examine their approach to fair lending risk management. Given the complexity and sensitivity of the current environment, banks need to ensure that they and their customers are appropriately protected.

Enforcement activity in the area of fair lending seemingly has been reduced, as evidenced by a relatively low number of fair lending cases advanced by the Department of Justice in recent years. However, the overall focus on fair lending enforcement is expected to increase during the tenure of the current administration, which is creating the Consumer Financial Protection Agency to oversee all aspects of the various consumer protection regulations. If fair lending enforcement

increases, more compliance programs will fail with regard to fair lending risks as a result of the increase in mortgage refinances and modifications inspired by government programs and historically low interest rates. Additional supervisory and enforcement activity likely will increase, as will scrutiny by consumer advocacy groups interested in matters related to fair and responsible lending.

The Potential Unintended Impact of Loan Modification Programs The U.S. Department of Treasury’s $50 billion Home Affordable Modification Program was designed in part to address past abuses in mortgage lending and to help homeowners at risk of foreclosure to stay in their homes. 2 Thus far, more than 200,000 homeowners have initiated applications for a loan modification—with another 270,000 applications expected before the end of the year. 3 The program provides mortgage lenders and servicers with incentives to modify mortgage loans (those originated on or before Jan. 1, 2009) by making the terms more favorable, provided those changes are effective at preventing

homeowners from falling behind on their mortgage loan payments for a prescribed period of time.

The success of this program, as well as the U.S. Department of Housing and Urban Development’s HOPE for Homeowners program4—which provides similar incentives for certain mortgage refinancing—remains the subject of great debate on a number of fronts. The modification program, originally intended to assist four million homeowners, has facilitated more than 200,000 modifications to date, despite its being a focus of the Obama administration, the media, and many groups with a vested interest in the program’s success. To address the concerns that the program has not yet reached enough homeowners who could benefit from the program, the Treasury Department has stated that by Nov. 1, 2009, it wants to see an additional 300,000 loan modification applications underway. 5

Such an aggressive commitment is likely to place additional strain on an already fractured mortgage banking infrastructure, and concerns are beginning to emerge that the pressure of these programs will increase the risk of noncompliance in fair lending practices. Many mortgage servicers— both large and small—have already been accused of harassing borrowers and charging excessive fees for loan modifications, 6 and some servicers specializing in higher-risk or subprime loans also have been accused of systematically abusing borrowers. These accusations undermine the intended purpose of the very programs that have provided substantial revenue to industry participants, including some