The Obama administration’s $275 billion plan to help up to 9 million families restructure or refinance their mortgages offers carrots for borrowers and lenders, including incentive payments and partial guarantees against losses for lenders who agree to modify loans.
But the administration is also seeking a stick: granting bankruptcy judges the power to modify the terms of mortgages when borrowers end up in their courts, regardless of whether lenders agree to go along.
The mortgage lending industry has long opposed these so-called "cram-downs" of mortgages in bankruptcy court, saying the practice will drive up the cost of home loans for all borrowers.
Although the Obama administration will be able to implement some aspects of its homeowner affordability and stability plan without congressional action, cram-downs would require an act of Congress to amend the bankruptcy code.
Carrots for loan mods
Carrots for the lending industry in the plan rolled out today include a $75 billion homeowner stability initiative that the Treasury Department estimates could prop up the average home price by $6,000 by facilitating 3 million to 4 million loan modifications.
The stability initiative would pay loan servicers a $1,000 upfront fee for each loan modification they make that meets the program’s guidelines, plus $1,000 a year for up to three years when borrowers stay current on their loans.
The guidelines would require lenders to reduce a loan’s interest rate so that a borrower’s monthly mortgage payment is no more than 38 percent of the borrower’s income. The initiative would then provide dollar-for-dollar matches for further interest-rate reductions to bring mortgage payments down to 31 percent of a borrower’s income.
The lower rates would have to remain in place for five years, after which they would gradually step back up to the rate in place when the loan was modified. Borrowers would also be eligible for incentive payments — up to $1,000 a year for five years as long as they are current on their loan.
The homeowner stability initiative would also create a new insurance fund of up to $10 billion to partially insure lenders against losses on modified loans. Payments to lenders would be tied to declines in the home-price index — helping assuage fears that engaging in loan workouts rather than foreclosing on homes now is a mistake if home prices will continue to fall.
The loan modification program is focused on borrowers with high mortgage debt or who are "underwater" — meaning they owe more on their home than it’s currently worth. Homeowners whose total debt is 55 percent or more of their income can still qualify, but will have to agree to enter a HUD-certified consumer debt counseling program.
The Obama administration said it would also enlist Fannie Mae and Freddie Mac in a new program it expects to produce 4 million to 5 million loan refinancings.
That program is aimed at helping homeowners who made down payments when taking out conforming loans owned or guaranteed by Fannie or Freddie, but who have since seen the value of their homes decline to the point where they have less than 20 percent equity — making it difficult to refinance into a low-cost home.
The administration cited a family that made a 20 percent down payment on a $260,000 home that’s now worth only $221,000 as an example of a borrower who would be eligible for the refinance plan. The refinancing plan would allow the hypothetical family to refinance their 6.5 percent mortgage to around 5.16 percent — saving them $2,300 a year despite having less than 10 percent equity in their home.
To support low mortgage rates for borrowers who qualify for loans eligible for purchase or guarantee by Fannie and Freddie, the Obama administration said it stood ready to buy up to $200 billion in preferred stock in each company, doubling the existing commitment of $100 billion each.
That appropriation was previously authorized by Congress in July 2008 under the Housing and Economic Recovery Act, and does not use any money from the $787 billion financial stimulus bill signed into law Tuesday or the $700 billion Troubled Asset Relief Program (TARP).
The $75 billion homeowner stability initiative will reportedly rely on $50 billion from TARP, and another $25 billion from Fannie Mae and Freddie Mac.
Fannie and Freddie will each be allowed to increase their retained mortgage portfolios — loans the companies hold for investment — to $900 billion, an increase of about 6 percent from the existing limit of $850 billion.
The Center for Responsible Lending welcomed the plan, saying it recognizes that "voluntary actions to avert foreclosures without real government action simply have not worked. With this plan in place, there will be more options and incentives for servicers and investors to avoid foreclosures that don’t need to happen."
Granting bankruptcy judges cram-down powers "will provide a new avenue for reducing hundreds of thousands of foreclosures without requiring any tax dollars," the center said — and provide stronger incentives for loan servicers to enter into voluntary loan modifications.
John Courson, president and CEO of the Mortgage Bankers Association, said that while the group was encouraged by the variety of alternatives the plan offered borrowers to avoid foreclosure, it seemed to offer little help to borrowers whose loan exceeds their property value by more than 5 percent.
The 105 percent loan-to-value ratio limit on refinancing will limit the plan’s success in some of the hardest hit areas in California, Florida, Nevada and Arizona, as well as some areas on the East Coast, Courson said.
The plan also offers no assistance to borrowers with jumbo mortgages and those whose mortgages are in private label securities, Courson said.
Dan Green, a Cincinnati-based loan officer for Mobium Mortgage Group Inc., said the government is taking a broad approach to the fundamental issues of supply and demand.
"Falling prices are symptomatic of a lack of demand or too much supply," Green said. "The government can’t control prices, but they can influence supply and demand. This is a broad approach, and they are hitting the market in so many places, it’s OK if one of them fails."
Green recently blogged about one example of this broad approach: Fannie Mae this month announced it is increasing from four to 10 the number of single-family loans it will provide financing for, for experienced investors with good credit.
"All this stuff is related," Green said. Other incentives on the demand side include the $8,000 tax credit for first-time homebuyers in the economic stimulus bill signed into law Tuesday (see story).
On the supply side, the Obama administration’s claims that it can prevent as many as 9 million foreclosures may prove to be overly optimistic, as were similar claims made by the Bush administration when it rolled out new programs.
But Green noted that transactions in many markets are up as investors snatch up distressed properties at bargain prices, and that homebuilders have cut production of new homes drastically.
"That’s getting inventory off the market, and all that was happening before Fannie opened up to 10 units per person," Green said. "I hear investors show up at an auction and say they want to buy more but they can’t — they are handcuffed" by financing issues.
Dismal numbers on housing starts released today are actually a good sign, Green said, because builders aren’t adding more supply.
The Commerce Department reported that housing starts dropped 16.8 percent from December to January, to a seasonally adjusted annual rate of 466,000 units. That’s a 56.2 percent drop in the rate of new home construction from a year ago.
"Everybody says it’s a terrible sign that the economy is in bad shape — it’s actually hastening the recovery," Green said. "I think we’ll look back and see December 2008 was the start of the housing recovery."
The American Bankers Association called the plan "a constructive, flexible and multifaceted initiative" that’s "likely to have a positive effect on preventing mortgage foreclosures."
The plan represents a "major commitment of funding sufficient in scope to have a significant impact," the group said, aimed at the homeowners who are most likely to avoid foreclosure.
While many aspects of the administration’s plan to boost loan modifications and refinancings were welcomed by real estate and consumer groups, the administration’s continued support for changes to the bankruptcy code may prove worrisome to mortgage lenders.
So-called mortgage cram-downs have been a hot-button issue since the fall of 2007, when Sen. Dick Durbin, D-Ill., introduced legislation that would have amended the bankruptcy code to give judges the power to modify mortgage loans, including principal reductions (see story).
Bankruptcy judges already have the power to restructure other consumer debt, such as car loans and credit-card loans, when they see opportunities to provide troubled borrowers relief without relieving them of all their obligations to repay creditors. Bankruptcy judges can even modify the terms of a mortgage on an investment property or vacation home, but not a borrower’s principal residence.
Many in the mortgage lending industry want to preserve the protections against cram-downs on most home loans, saying that all borrowers can expect to pay more if they are lifted.
Critics of cram-downs say bankruptcy courts would be flooded with indebted homeowners, and that investors who fund mortgage lending through the purchase of mortgage-backed securities would demand greater returns if they perceived there was a risk that the loans could be modified without their consent.
Although the cram-down legislation being considered by Congress would apply only to some loans made during the housing boom — loans made in the future would remain exempt — critics say that if Congress demonstrates a willingness to change the rules of the game once, there are no assurances it won’t do so again.
Many who support granting bankruptcy judges more power to modify mortgages say the lending industry has overstated the potential impacts for borrowers, and that the prospect of borrowers ending up in bankruptcy court would serve as an incentive for lenders to do more voluntary loan modifications.
The Obama administration said it will seek "careful changes" to the bankruptcy code to allow modifications of mortgages written "in the past few years" when borrowers run out of other options.
Only existing mortgages under Fannie Mae and Freddie Mac’s conforming loan limits would be eligible for court-ordered modifications, so that "millionaire homes don’t clog the bankruptcy courts," the administration said.
The bankruptcy code would be changed so that mortgage loans exceeding the current value of a property would be treated as unsecured, allowing a bankruptcy judge to develop a plan for the homeowner to make payments that are affordable.
To be eligible for a cram-down, homeowners would be required to first ask their lender or loan servicer for a modification, and certify that they have complied with "reasonable requests from the servicer to provide essential information."
Last month, Durbin announced that Citigroup had agreed to support his cram-down bill after the bill’s sponsors agreed to limit the legislation to existing mortgages, and require homeowners to contact their lender about a modification before filing for bankruptcy.
Mortgage Bankers Association Chairman David Kittle said borrowers who can’t be helped by the Obama administration’s new loan modification and refinancing measures are also likely to have a hard time regaining their footing in bankruptcy court.
"Our fear is that … their bankruptcy plan will fail, they will lose their home anyway, and will now be stuck with the black mark of bankruptcy on their record" making it harder to buy or rent a home in the future, Kittle said.
While welcoming many aspects of the plan, the American Bankers Association also said it was committed to "working closely with the administration as it completes the remaining details of the plan."
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