Why Are Big Banks Easing Mortgage Terms?

JPMorgan Chase (NYSE:JPM) and Bank of America (NYSE:BAC) are “quietly modifying loans” for borrowers not even in default, cutting debt and easing mortgage terms for borrowers deemed to be at risk by the banks. Banks are being proactive over pay option adjustable rate mortgages (option ARMs), popular before the financial crisis when the housing market was booming, but now at heightened risk for default. Many of these borrowers end up owing more on their mortgages than their homes are worth, which prevents them from moving and taking new jobs.

But many borrowers receiving the unsolicited relief are suspicious both of the actual status of their mortgages and of the banks’ (NYSE:XLF) motives. According to Federal Reserve economists, cutting loan balances, even on loans in default, is so rare that the Fed said they “could find no evidence that any lender was actually reducing principal” on mortgages, according to a paper published back in March.

Option ARM loans give borrowers the option of skipping the principal payment as well as some of the interest payments on their loans in the first few years, which will ultimately be added to the body of the loan. Both Chase (NYSE:JPM) and Bank of America inherited their portfolios of option ARMs in acquisitions during the housing crash. Chase received $50 billion in option ARM loans when it bought Washington Mutual in 2008, and Bank of America (NYSE:BAC) acquired 550,000 option ARMs when it bought Countrywide Financial that same year.

Dan B. Frahm, a spokesman for Bank of America (NYSE:BAC), says they are remaking loans in hopes of preventing option ARM customers from reaching a point where they can no longer make their payments. Currently, Chase, Bank of America, and other lenders are in talks with the Obama administration and attorneys general around the country about how best to deal with debt forgiveness and determining who deserves to be helped.

Banks don’t want to cut mortgage balances for struggling borrowers because it would both be unfair to borrowers who remain current on their payments, as well as hurt investors who own pools of securitized loans. But Bank of America and Chase (NYSE:JPM) are being criticized for doing for borrowers not in default what they didn’t do for borrowers in default. Last month, regulators penalized both institutions for doing a poor job modifying mortgages in default, but now they’re modifying mortgages for borrowers who have been consistently making their payments and have demonstrated no other risk of default besides having an option ARM loan.

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