Cuts in short-term interest rates have reduced the payment shock of adjustable-rate mortgage resets, and although foreclosure starts continued to grow in January, loan servicers increased the number of loan modifications at a faster pace.

That was the word from Treasury Secretary Henry Paulson on Monday, as he restated the Bush administration’s arguments against a government bailout of mortgage lenders before the National Association of Business Economists.

Paulson said loan servicers participating in the administration’s voluntary HOPE NOW initiative engaged in 167,000 loan workouts in January, up 11 percent from December. Loan modifications increased 19 percent from the previous month, compared with a 5 percent increase in foreclosure starts, Paulson said.

All HOPE NOW loan servicers have now implemented standards developed by the American Securitization Forum for streamlining loan workouts, compared with about half at the end of January, Paulson said. But 80 percent of 1 million at-risk homeowners who have been mailed letters urging them to contact their lender have not responded, Paulson said.

The 20 percent response rate to the letters is better than the 2 to 3 percent response rate by delinquent borrowers before the HOPE NOW alliance was formed, but "homeowners must actively engage with their lenders and demonstrate that they want to keep their homes," Paulson said.

It’s likely that falling home prices have left 8.8 million homeowners upside down — with no equity, or owing more on their mortgage than their house is worth — Paulson noted, citing a recent report by Moody’s

And an oversupply of housing — about 10 months of inventory for both new and existing homes — could be worsened by an estimated 2 million foreclosure starts in 2008, Paulson said.

In testimony before the House Financial Services Committee last week, Moody’s Chief Economist Mark Zandi estimated that even if loan servicers step up the pace of loan modifications, he expects well over 3 million mortgage defaults this year and next, and envisions about two-thirds of those homes going all the way through the foreclosure process.

But the single most significant factor benefiting all ARM borrowers is the recent decline in short-term interest rates, Paulson said, which "are very significantly mitigating the effects of mortgage resets."

A typical subprime loan resetting in December might have involved a rate increase from 8.5 to 10.8 percent. But because the Federal Reserve has cut the federal funds overnight rate five times since September, reducing it from 5.25 percent to 3 percent, the same ARM loan might carry a 9 percent interest rate after a reset, Paulson said.

That means instead of going up by more than $300 a month, the typical payment on a $200,000 mortgage will increase by only $70. As many as half the borrowers who would have been fast-tracked for a loan modification in December escaped significant ARM resets in January. Lower rates, rather than loan modifications, helped these borrowers avoid foreclosure, Paulson said.

The improving picture for subprime ARM resets could have an impact on foreclosures, because while such loans represent only 6.5 percent of all mortgages, they were involved in 40 percent of third-quarter 2007 foreclosure starts, Paulson said.

Paulson said the Bush administration remains committed to expanding the scope of FHA loan guarantee programs through a bill now pending in Congress, which must also move to improve oversight of Fannie Mae and Freddie Mac, he said.

Paulson noted that a stimulus package approved by Congress and signed into law by President Bush will inject $150 billion into the economy this year and projected it would create 500,000 new jobs. The stimulus package will also increase the maximum-size mortgage eligible for backing by FHA, Fannie or Freddie to $729,750 in high-cost areas.

The National Community Reinvestment Coalition issued a statement countering Paulson’s remarks, saying statistics released by HOPE NOW "do not adequately describe how borrowers are being assisted" and that most loan modifications publicized so far have been short-term adjustments.

Some 40 percent of foreclosures on subprime ARMs in the third quarter of 2007 involved loans that had already undergone a modification, NCRC said, citing the Mortgage Bankers Association.

NCRC is among groups calling for the federal government to buy up mortgages held in securitized pools at a discount so that the loans could be permanently modified or refinanced.

"Let me be clear: I oppose any bailout," Paulson said. "I believe our efforts are best focused on helping homeowners who want to stay in their homes."


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