Obama's more comprehensive Homeowner Affordability and Stability Plan, the intent of which is to reduce foreclosures and stabalize the real estate markets. Since every government program needs a acronym (TARP, TALF, etc.), I will refer to the loan modification program, designed to assist homeowners who are at risk of default and foreclosure avoid it, as "HAMP."
Which mortgages are eligible for HAMP?
To qualify for the HAMP, mortgages must meet the following requirements:
- The mortgage must be a first mortgage encumbering a 1-4 unit residential property that serves as the borrower's current primary residence.
- The borrower must have had a change in circumstances that causes financial hardship, or be facing a recent or imminent increase in the amount of the borrower's monthly payment that is likely to create a financial hardship.
- The unpaid principal balance of the mortgage must be no more than $729,750 (this
amount increases proportionately for multiple unit properties.)
- The mortgage can not have been previously modified under the HAMP.
- The mortgage must have been originated on or before January 1, 2009 (mortgages
are eligible to be modified until December 31, 2012)
Which eligible mortgages must be modified?
After determining that the mortgage is eligible based on the requirements set forth above, a net present value test must be performed on the mortgage. This test determines whether the estimated net present value of the mortgage, as modified, is greater than the estimated net present value of the mortgage absent modification. Relevant parameters for the net present value test include the estimated value of the property upon foreclosure, cure and redefault rates, the amount of any incentive payments made under the HAMP and other information affecting the potential future value of the mortgage. If the net present value test determines that the modified loan is more valuable, as modified, participating servicers are required to offer the borrower a modification. However, servicers have the option of offering borrowers a loan modification even if the modified loan is estimated to be less valuable. The Treasury will release further parameters for the net present value calculation at a later date.
How are loans modified pursuant to the HAMP?
1. Interest rate reduction. First, a servicer must attempt to reduce the interest rate for the mortgage in increments of 0.125% (subject to a floor of 2%) until a mortgage debt-to-income ratio (Front-End DTI Ratio) of 31% is reached. For purposes of calculating Front-End DTI Ratio, mortgage debt includes principal, interest, taxes, insurance, homeowners association and/or condominium fees and certain arrearages. Mortgage insurance premiums and debt service on subordinate liens are not included. If the interest rate required to reach a Front-End DTI Ratio of 31% is above an interest rate cap (set at the lesser of: (a) the original contractual rate, or, (b) the current Freddie Mac Primary Mortgage
Market Survey rate) the modified rate will become the interest rate for the remainder of the term of the mortgage. If the modified interest rate is below the cap set forth above, the modified rate will remain in effect for the first five years and then increase by 1% per year until it reaches the level of the cap, at which time it will be fixed.
2. Extension of term or amortization. If a Front-End DTI Ratio of 31% cannot be reached by lowering the interest rate to 2%, servicers may extend the term of the mortgage to up to 40 years. If loan terms prohibit extending the term, the amortization period can be increased to up to 40 years, which will result in a balloon payment that will be due upon the maturity or other termination of the
loan.
3. Forbearance of principal. If the above steps still do not result in a Front-End DTI Ratio of less than 31%, servicers may forbear principal, which would then become due upon the maturity or other dermination of the loan. The guidelines mandate that interest cannot accrue on the forbearance amount.
4. Trial period. After the modified interest rate is determined, the borrower engages in a trial period lasting 90 days, or 3 payment periods, during which the borrower must make payments at the modified terms. If the borrower is current at the end of the trial period, the modification is then effective.
What incentives are available in connection with the HAMP?
Acknowledging the failure of prior loan modification programs, the Obama plan provides a variety of incentives to lenders and servicers to gain their participation on more loan modifications.
Lenders (or whoever owns the mortgage in this era of securitization) are eligible for the following incentive payments from the government:
- A payment in the amount of one-half of the difference between the borrower's monthly payment, as modified, and the lesser of: (a) the monthly payment of the loan at a 38% Front-End DTI Ratio, or, (b) the borrower's current monthly payment. This compensation will be paid for up to five years.
- A bonus incentive of $1,500 for any loan modified while the borrower is still current (including less than 30 days delinquent), subject to de minimis restraints.
- Compensation to partially offset probable losses from home price declines for loans that have already been modified.
2. Servicers. Servicers, including lenders that service their own loans, are eligible for the following incentive payments:
- An initial payment of $1,000 for each successful modification.
- Annual payments of up to $1,000 for the first three years following successful modification, provided the borrower stays in the program.
- A bonus incentive of $500 for any loan modified while the borrower is still current (including less than 30 days delinquent), subject to de minimis restraints.
Even borrowers, who have already obtained the benefit of having their loans modified, get sweeteners from the governent. For example, if the borrower makes mortgage payments on time during the first five years after the modification, the principal on the loan will be reduced by an additional $1,000 each year.
What are the potential problems with HAMP?
In addition to obvious moral hazard seemingly present in all of the government bailouts, loan modifications create problems for investors in mortgage-backed securities. Most of the mortgages in this country are owned in some way or another by investors who have already taken huge losses on their investments in these securities. Loan modifications may be opposed by investors, and may result in litigation as it did when Countrywide (now owned by Bank of America) settled predatory lending charges by various State Attorneys General by agreeing to modify thousands of mortgages. Investors in the mortgage-backed securities containing these Countrywide loans banded together and brought litigation to prevent the modifications. The Treasury guidelines do not really address this, but state that servicers must comply with the terms contained in servicing agreements (including pooling and servicing agreements) for eligible mortgages, or make reasonable efforts to remove any prohibitions or obtain waivers from any necessary party.
The plan also presents additional problems for lenders and servicers. The guidelines prohibit servicers from passing along most charges in connection with loan modifications. For instance, while notary fees, property valuation and other required fees may be reimbursable from a lender or investor, servicers cannot pass these costs to borrowers. In addition, servicers cannot require a borrower to contribute cash to the closing of a loan modification, and must waive any unpaid late fees. Servicers participating in the HAMP are required to enter into service contracts with Treasury's financial agent prior to December 31, 2009. These service contracts are likely to require servicers to offer loan modifications to all eligible mortgages in a servicer's loan portfolio. Treasury expects to circulate examples of these contracts in April 2009. Servicers performing loan modifications will also be subject to detailed data gathering and recordkeeping requirements. Treasury will issue details on these requirements at a later date.
Additional information is available on the Treasury Department's website here, here and here.