The banks that settled a nationwide probe of foreclosure practices last month will get a bonus from the deal. The bonus is protection for $308 billion of home-equity loans they hold. The banks that service about half the nation’s mortgages on behalf of investors will be able to share losses on their junior loans with bondholders. And, they will get credit toward the cash they pledged to spend in the settlement. Loss-sharing will clear the jam that occurs when banks drag their feet processing modifications on mortgages that outrank their junior liens.
Government foreclosure-prevention programs have resulted in less than 1 million modifications; a quarter of the goal the administrators set three years ago. Home-equity mortgages have been a reason for that because the servicers want to protect their second liens. The credits banks will get for writing down home equity loans won’t be as much. In comparison to what will get for reducing the balance on primary mortgages.
In fact, about 92 percent of home equity loans are held on the balance sheets of US banks. The five banks in the mortgage settlement own 42 percent of the second liens. This makes it very likely a servicer of the primary mortgage will hold a property’s junior loan. A conflict arises. This is because the servicer has a financial incentive to service the first lien to the benefit of the second-lien holder; which may oppose the financial interest of the investor.
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