Third Circuit Ruling Could Reduce Value Of Modified Loans Serviced Under Fannie Mae And Freddie Mac Guidelines

The value of modified home loans serviced under Fannie Mae and Freddie Mac guidelines could be diminished by a March 9, 2017 ruling against JP Morgan Chase Bank in Fried v. JP Morgan Chase & Co., No. 16-3069,  2017 WL 929752 (3d. Cir. Mar 9, 2017). The ruling calls into question the manner in which the termination deadline for private mortgage insurance ("PMI") should be calculated.  But more significantly, it creates questions regarding the value of modified mortgages that are packaged as investment products.

In Fried, a mortgagor brought a class action lawsuit against JP Morgan Chase & Co. ("JP Morgan") alleging that JP Morgan violated the Homeowners Protection Act ("HPA") when it modified her mortgage to reduce the outstanding principal balance.  The basis for the alleged HPA violation was that JP Morgan relied on a Broker's Price Opinion ("BPO") received at the time of the loan modification in order to calculate a PMI termination date instead of using the appraisal of the borrower's home received at the time the loan was originated.  The impact of using the BPO (which indicated the value of the home had reduced from an appraised value of $570,000 at origination to $420,000)  was that the termination date for PMI that Fried was required to pay on the loan extended by over 12 years.  Based on these facts, the Court held that the HPA "sets a finish line (i.e., the termination date) for each homeowner's mortgage insurance obligation on the basis of her home's original value and measures her progress toward it by looking to her outstanding principal balance."  Fried's mortgage modification decreased her principal balance, but her home's original value under the HPA did not change.  The modification thus moved her toward the finish line and although her home had dropped in value, the drop in value did not move the finish line.

The ruling obviously impacts the manner in which mortgage servicers modify loans and calculate PMI.  Perhaps more significantly, and as pointed out by briefs filed in the case by multiple banking groups including the American Bankers Association, Mortgage Bankers Association and Independent Community Bankers of America, this ruling could reduce the value of investment products based on modified loans.  In particular, the ruling harms lenders and consumers by calling various existing mortgage sales contracts on the secondary market into question.  The primary mortgage market—actual loans to homeowners to buy or refinance homes—is largely financed by the resale of those mortgages on the secondary market.  Mortgage resales provide investment capital for new mortgages, creating a liquid, accessible market for homebuyers.  Fannie Mae and Freddie Mac in turn securitize these mortgages, creating desirable investment products that, again, help capitalize the primary mortgage market.

The secondary sales contracts generally guarantee that the underlying mortgages will adhere to Fannie Mae's guidelines.  And Fannie Mae's and Freddie Mac's influence leads purchasers and investors to believe that these mortgages, and their resulting securities, are comparatively safe products.  The district court's ruling will call these sales contracts into question and could also reduce modified mortgages' eventual fitness as part of investment products.  Besides exposing lenders to some risk on their contracts, this could prevent some investors from entering the secondary mortgage market—and therefore could reduce mortgage credit availability for middle and lower-income buyers.