Mortgage servicers frequently disregard bankruptcy law and submit inadequate or erroneous claims, a university law professor alleged in a recent 48-page report that indicated lenders and borrowers disagreed on the balance owing in most cases. She suggested illegal fees regularly tacked on to balances without sufficiently identifying the nature of the fees are symptomatic of servicing in general.
Servicers, whose loyalty lies with investors of mortgage-backed securities, have financial incentives to overcharge borrowers, according to Misbehavior and Mistake in Bankruptcy Mortgage Claims authored by University of Iowa Associate Professor of Law Katherine Porter. Their motivation is derived from fee arrangements based on a percentage of the balance, float from the time payments are received to when they are remitted to investors and their retention of additional charges.
"Servicers boost their profits when they charge excessive fees, impose late charges, or create hurdles for borrowers who are trying to cure defaults and stop a cascade of fees," Porter wrote. "A borrower's default can present a servicer with an opportunity for additional profits."
The author based her findings on a study of 1,733 Chapter 13 bankruptcy cases involving a mortgage filed between April 1, 2006, and April 30, 2006. Tara Twomey helped her investigate for the study.
The report cited the lawsuit Rawlings v. Dovenmuehle Mortgage Inc., in which the borrowers allegedly spent more than seven months fighting late fees and default notices because Dovenmuehle applied the Rawlings' mortgage payment to the wrong loan.
In another cited case, Islam v. Option One Mortgage Corp., the borrowers spent over a year to stop delinquency notices and correct erroneous credit reporting from a new servicer even though the loan had been refinanced and paid off by a new lender.
A settlement between Fairbanks Capital Corp. and the Federal Trade Commission in 2003 for $47 million resulted from the company's overcharges and lack of reporting to borrowers -- some who lost homes to foreclosure, according to the report. In one bankruptcy case, the court reportedly said Fairbanks "repeatedly fabricated the amount of the debtor's obligation to it out of thin air."
Porter suggested financially struggling servicers, who are cutting back, have fewer resources to deal with an increasing number of delinquent borrowers.
In one Chapter 13 bankruptcy case, where borrowers can seek temporary relief from foreclosure but are required to still make payment, the servicer filed a proof of claim in the amount of $1 million on a $60,000 loan because of a "mistake in reporting the cost of the insurance policy that the servicer forced on the debtor after the debtor's insurance lapsed."
In another case, Jones v. Wells Fargo Home Mortgage, the court reportedly said Wells' documentation was "such a tangled mess that neither debtor, who is a certified public accountant, nor Wells Fargo's own representative could fully understand or explain the accounting offered."
"Mistakes or misconduct by mortgage companies jeopardize the ability of courts and trustees to administer bankruptcy cases correctly and fairly," the report stated. "Other creditors are harmed if mortgage companies wrongly divert money that should be available to pay unsecured creditors."
Among a number of problems bankruptcy trustees have reportedly complained about were claims without loan balances, claims where balances were bloated with illegal and fraudulent fees and subsequent proofs of claim that conflicted with original claims.
The report indicated that 41 percent of bankruptcy claims examined were missing required notes, while proof of the security interest was missing nearly 20 percent of the time. The tolerance for missing documentation varied by judicial district.
The professor said her research uncovered a number of illegal or unreasonable fees that servicers tried to collect. Specific case examples included attorney's fees of $31,273; bankruptcy fees and costs of $2,275; broker price opinion fees of $1,489; and overnight delivery fees of $137.
Subprime lending has only exacerbated the claims problems.
In about 95 percent of the bankruptcy cases, servicers and borrowers disagreed on the amount owing, though around one-quarter of claims filed by servicers had amounts less than what than what the borrower claimed. For all bankruptcy cases, the median discrepancy amount was $1,366 while the average discrepancy was $3,533.
"Based solely on the Mortgage Study sample of approximately 1,700 loans, millions of dollars may be overpaid to mortgagees," Porter wrote. "On an aggregate basis, the discrepancies between debtors and mortgagees are a multi-billion dollar problem."
But despite her findings, "Mortgage creditors are rarely called to task for the widespread deficiencies or inaccuracies in their proofs of claim."
The report suggested borrowers be given an option to change servicers.
"Empirical data show that many mortgagees fail to comply with applicable law and, in fact, may be collecting unreasonable or illegal fees in the context of the bankruptcy claims process," Porter concluded. "Systematic reform of the mortgage servicing industry is needed to protect all homeowners -- inside and outside of bankruptcy -- from overreaching or illegal behavior."