Proactive government and bank efforts to help distressed borrowers have largely, if not exclusively, been focused on ‘home retention’ programs in 2009. On the one hand this focus makes sense: the first question that should be asked and answered when a family stops making their mortgage payment due to financial hardship is whether an change to the loan terms would make the home affordable for the same borrower (thereby avoiding all the negative effects of a pre or post foreclosure home sale) while being acceptable to the investor.
On the other hand, given constrained resources this almost exclusive focus on home retention, which has come thus far at the expense of those that could not afford to keep ownership of their home, has been a little confusing to me, a former Chief People Officer who had to layoff over 7000 people between mid-2007 and mid-2008 due to the mortgage crisis. Most of these above mentioned responsible employees of my former mortgage bank employer, unfortunately fall into the latter category of families who would not be able to afford homes they once could, and I think we have missed the boat thus far on properly providing and supporting home and life transitions for these families.
My issue with the focus of government and bank programs thus far is not that they shouldn’t focus on helping every family in trouble first try to keep their home if they want…but on the public message and conversation we are having.
America is undergoing a fundamental shift in consumer behavior and economic activity today, and as Charles Darwin said, ‘It’s not the strongest species that survive, nor the most intelligent. It’s the ones most adaptable to change’.
Americans (myself included) need to adapt to the new economy…and if this means they need to sell their home and move…so be it. (Family), jobs and financial stability are more important, in my view, than holding onto a home one cannot afford.
Notwithstanding the above gap in proactive bank and government programs till date, let’s circle back to the issue of home retention first. Early results are in on government and bank home retention efforts…and performance thus far is viewed as below expectations. Only about 20% of the families in trouble have been provided a temporary modification (mod) yet…and conversion rates of these temporary mods to permanent mods are very low thus far. 2 things should be noted before one judge’s the above too soon:
1. The number of loan modifications attempted (this is where progress starts – with a step in the right direction) is significantly larger than in the previous year/s and under the previous administration/team
2. In some ways, the problem isn’t the number of people in trial mods. While lots of effort is and will be put on solving the current problem (hopefully successfully) of converting the 75% or so performing trial mods into permanent ones (except where there was mis-statement of income, which is not kosher in my view), the real issue is improperly set expectations…and lack of enough alternate modification programs (addressing the diversity in situation among those in trouble right now).
A key flaw in most loan modifications offered today including HAMP is highlighted by the article I am including below on a recent by the New York Federal Reserve Bank: they do not address the issue of negative equity.
Since 25% of US homeowners have negative equity today, and since our national goal is to do more to help those in trouble who want to retain their home, I thought I’d resurface a simple loan modification proposal I first introduced in an April 2009 blog….which I believe could significantly expand the success of our home retention efforts.
Responsible Second Chances: A break today in exchange for some of tomorrow’s upside
For every American family who is unable to afford the payment on their primary residence, I would offer them a one page loan modification with the following terms:
1. Reduction in loan principal down to current market value.
2. 30 year fixed mortgage at current historically low market rates.
3. 25% of any equity appreciation from the written down loan principal (the remaining 75% would go back to the investor taking the loss on the principal write-down today)…thereby reducing the bite of the loss of principal taken today.
4. Requirement that if the borrower misses more than 3 mortgage payments again and is unable to reinstate their loan, they would voluntarily exit the property within 6 months of falling behind…either via a Short Sale or Voluntary Foreclosure.
Why do I think the program above would help many not being helped today? Here’s why:
1. It addresses the issue of negative equity…which is critical, per the article and study mentioned below
2. It is ‘economically’ the right answer (in effect, any family that can afford their home today at current values and mortgage rates, gets to keep it)
3. It addresses the issue of moral hazard: there’s no free lunch in America (at least not for long). The family gives up 75% future equity appreciation in exchange for the investor taking a significant loss on the loan today (via the principal write-down). This should largely eliminate, in my view, the need to collect financial hardship documentation…which is a key reason many mods are not becoming permanent today.
4. It is simple to understand, unlike the HAMP program…which does not result in a principal reduction, as many borrowers applying for HAMP mistakenly believe it does.
5. It addresses the issue of what happens if the loan goes bad again…which is important for the investor who is making a big compromise today.
Implementability
It is likely my proposal is not implementable in many parts of the private market…particularly the securitized loan market. However, it could be implemented for government sponsored and owned enterprises…Fannie Mae, Freddie Mac and FHA…which represent a large part of the market.
Article from DSNews.com: Fed Study Finds Principal Writedowns Minimize Risk of Redefault
Servicers who lower distressed homeowners’ mortgage payments by reducing the principal balance, as opposed to just making interest rate adjustments, are much more likely to see the payments keep coming in and ward off a redefault, according to a new study published by the Federal Reserve Bank of New York.
The economists found a definite pattern among modifications made since December 2005 that suggests “an intention among servicers to make the loans more affordable, while not losing any of the underlying principle.” However, their analysis shows that modifications that trim off some of the loan balance have higher rates of success and “can double the reduction in re-default rates.”
While principal writedowns essentially mean the lender or investor must eat a loss, many analysts argue that it’s a smaller loss than comes with the eventual foreclosure and the price tag of a nonperforming asset in today’s housing market, already swollen with REO inventories and vacant properties.
According to the New York Fed’s economists, when a borrower’s monthly mortgage payment is cut by 25 percent by reducing the interest rate only, the borrower is 11 percent less likely to default within one year.
But, if the monthly payment is lowered by the same 25 percent, this time by shaving 25 percent off of the outstanding loan balance, coupled with a small interest rate cut, the chances that the borrower will defaulting again within one year drops by nearly 27 percent.
The report’s authors also concluded that borrowers who have a loan-to-value (LTV) ratio of 115 percent or higher – meaning they owe 15 percent or more than their homes are worth – pose a 51 percent higher risk of redefaulting after a modification.
According to a blog by Wall Street Journal reporter Nick Timiraos, the findings of the New York Fed paper could have big implications on the administration’s Home Affordable Modification Program (HAMP). Timiraos explained that while the program doesn’t preclude principal forgiveness on the part of lenders, HAMP’s primary push is on lowering interest rates and extending the loan term to bring monthly payments down – exactly the types of modifications that the Fed report says have a higher chance of becoming delinquent again.
The Congressional Oversight Panel and the special inspector general for the Troubled Asset Relief Program (TARP) have criticized the government’s mortgage modification efforts on numerous occasions for not addressing the issue of negative equity, which would ultimately involve trimming LTV ratios by shaving off outstanding mortgage balances.
A growing number of mortgage experts and foreclosure counselors agree with the federal watchdogs and the New York Fed economists that principal reduction is a powerful incentive for borrowers to keep up with their restructured payments, particularly now, when such a large number of mortgages are underwater.
First American CoreLogic says that nearly 10.7 million, or 23 percent, of the residential mortgages in the United States had negative equity at the end of the third quarter of 2009, with the homeowner owing more on the home than it was worth.
A modification is only worthwhile if it induces borrowers who would otherwise default to continue paying, the New York Fed’s economists noted, and they argue in their analysis that borrowers with positive equity in their properties have a strong incentive to keep current on their mortgage, since delinquency and foreclosure will ultimately lead to a loss of the asset.
“In fact,” they wrote, “borrowers with positive equity (that is, borrowers whose house is worth more than the balance on their mortgage) should rarely default, since refinancing the mortgage or selling the property are better options than foreclosure, which may cause the borrower to lose [their] equity.”
