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.
Dangling Vegetables
Carrots for the lending industry in the plan rolled out last week 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.
Paging Fannie And Freddie
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.
Stimulating Reaction
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 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.
