New Mortgage Modification Plan Causes Conflicts with Home Equity Portfolios

Large first mortgage servicers have just been handed a potentially dangerous incentive to help their second mortgage portfolios. The Obama administration's new loan modification plan, Home Affordable Modification Program, strongly encourages mortgage servicers to restructure first mortgages.

That is certainly the effect the administration the White House intended. However, could this new and broader loan modification program present conflicts of interests?

Bank of America, JP Morgan Chase, Wells Fargo, and Citigroup are the top four first-mortgage servicers, holding $6.1 trillion in first mortgages, most of which are serviced on behalf of other financial institutions. Working out these mortgages could assist the performance of their $441 billion in collective home equity loans and lines of credit.

Home equity loans and lines became very popular during the recent mortgage refinance boom, helping borrowers avoid mortgage insurance. However, this trend is now contributing significantly to foreclosures and negative equity in American mortgages.

Mortgage refinancing or restructuring generally places the second lien into a stronger (senior) position to the renegotiated first contract. This is why first mortgage lenders generally require the second-lien holders to "subordinate" their position prior to refinancing the first mortgage.

The Treasury's guidelines on the mortgage modification is clear that additional incentives will be paid to encourage, but not require, the elimination of second-liens. These incentives are unspecified and lacks significant detail to understand how first and second-lien holders streamline the process. Second mortgages have already caused challenges for borrowers attempting to refinance and modify mortgages to date. The latest government loan modification program seems to suffer some of the same conflicts to success.