Mortgage Fanatic

Foreclosure's Wake: The Credit Experiences of Individuals Following Foreclosure (FRB)

2010-12-16T14:29:00.000-05:00

By Kenneth P. Brevoort and Cheryl R. Cooper

Abstract: While a substantial literature has examined the causes of mortgage foreclosure, there has been relatively little work on the consequences of foreclosure for the borrowers themselves. Using a large sample of anonymous credit bureau records, observed quarterly from 1999Q1 through 2010Q1, we examine the credit experiences of almost 350,000 borrowers before and after their mortgage foreclosure. Our analysis documents the substantial declines in credit scores that accompany foreclosure and examines the length of time it takes individuals to return their credit scores to pre-delinquency levels. The results suggest that, particularly for prime borrowers, credit score recovery comes slowly, if at all. This appears to be driven by persistently higher levels of delinquency on consumer credit (such as auto and credit card loans) in the years that follow foreclosure. Our results also indicate that the experiences of individuals whose mortgages entered foreclosure from 2007 to 2009 have followed a similar path to borrowers foreclosed earlier in the decade, though post-foreclosure delinquency rates for the recently foreclosed have been higher and, consequently, credit score recovery appears to be taking longer.

Download here: www.federalreserve.gov/pubs/feds/2010/201059/201059abs.html

Strategic Default on First and Second Lien Mortgages During the Financial Crisis

2010-12-16T07:49:00.001-05:00

By Julapa Jagtiani and William W. Lang (Philadelphia Fed)

Abstract: Strategic default behavior suggests that the default process is not only a matter of inability to pay. Economic costs and benefits affect the incidence and timing of defaults. As with prior research, the authors find that people default strategically as their home value falls below the mortgage value (exercise the put option to default on their first mortgage). While some of these homeowners default on both first mortgages and second lien home equity lines, a large portion of the delinquent borrowers have kept their second lien current during the recent financial crisis. These second liens, which are current but stand behind a seriously delinquent first mortgage, are subject to a high risk of default. On the other hand, relatively few borrowers default on their second liens while remaining current on their first. This paper explores the strategic factors that may affect borrower decisions to default on first vs. second lien mortgages. The authors find that borrowers are more likely to remain current on their second lien if it is a home equity line of credit (HELOC) as compared to a closed-end home equity loan. Moreover, the size of the unused line of credit is an important factor. Interestingly, they find evidence that the various mortgage loss mitigation programs also play a role in providing incentives for homeowners to default on their first mortgages.

Download here: www.philadelphiafed.org/research-and-data/publications/working-papers/2011/wp11-3.pdf

Mortgage Servicing (Adam Levitin and Tara Twomey)

2010-12-16T00:19:00.000-05:00

Abstract: This Article argues that a principal-agent problem plays a critical role in the current foreclosure crisis. A traditional mortgage lender decides whether to foreclose or restructure a defaulted loan based on its evaluation of the comparative net present value of those options. Most residential mortgage loans, however, are securitized. Securitized mortgage loans are managed by third-party mortgage servicers as agents for mortgage-backed securities ("MBS") investors.

Servicers‘ compensation structures create a principal-agent conflict between them and MBS investors. Servicers have no stake in the performance of mortgage loans, so they do not share investors‘ interest in maximizing the net present value of the loan. Instead, servicers‘ decision of whether to foreclose or modify a loan is based on their own cost and income structure, which is skewed toward foreclosure. The costs of this principal-agent conflict are thus externalized directly on homeowners and indirectly on communities and the housing market as a whole.

This Article reviews the economics and regulation of servicing and lays out the principal-agent problem. It explains why the Home Affordable Modification Program ("HAMP") has been unable to adequately address servicer incentive problems and suggests possible solutions, drawing on devices used in other securitization servicing markets. Correcting the principal-agent problem in mortgage servicing is critical for mitigating the negative social externalities from uneconomic foreclosures and ensuring greater protection for investors and homeowners.

Download the paper here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1324023

Foreclosure’s Wake: The Credit Experiences of Individuals Following Foreclosure

2010-11-21T16:31:00.002-05:00

By Kenneth P. Brevoort (FRB) and Cheryl R. Cooper (The Urban Institute)

Abstract: While a substantial literature has examined the causes of mortgage foreclosure, there has been relatively little work on the consequences of foreclosure for the borrowers themselves. Using a large sample of anonymous credit bureau records, observed quarterly from 1999Q1 through 2010Q1, we examine the credit experiences of almost 350,000 borrowers before and after their mortgage foreclosure. Our analysis documents the substantial declines in credit scores than accompany foreclosure and examines the length of time it takes individuals to return their credit scores to pre-delinquency levels. The results suggest that, particularly for prime borrowers, credit score recovery comes slowly, if at all. This appears to be driven by persistently higher levels of delinquency on consumer credit (such as auto and credit card loans) in the years that follow foreclosure. Our results also indicate that the experiences of individuals whose mortgages entered foreclosure from 2007 to 2009 have followed a similar path to borrowers foreclosed earlier in the decade, though post-foreclosure delinquency rates for the recently foreclosed have been higher and, consequently, credit score recovery appears to be taking longer.

Download here: www.fdic.gov/bank/analytical/cfr/mortgage_future_house_finance/papers/Brevoort.PDF

Your Credit Score Is a Ranking, Not a Score (Cleveland Fed)

2010-11-18T10:17:00.002-05:00

Credit scores are used in nearly every part of our lives, from applications for car loans, mortgages, credit cards, and car insurance to even some hiring decisions. It is well established that people with higher scores get better loans, have better jobs, and pay lower insurance premiums than people with lower scores. Because credit scores matter so much, many consumers regularly monitor their scores, and some try to improve them. But when people start paying closer attention, they are often puzzled by how and why their scores change over time.

Credit scores can be hard to figure out. They can change even when one’s behavior has not. Or the same exact credit score can qualify a borrower for a loan one year but not be high enough the next. Part of the apparent unpredictability comes from the common misunderstanding that a credit score is a rating of one’s creditworthiness. Actually, it is a ranking of one’s creditworthiness compared to the rest of the population in the United States at any point in time. In other words, your score depends not only on your credit behavior but also on the behavior of others. If your score changes over time, it means your rank-order among other consumers has changed.

Knowing more about who produces credit scores and how they are calculated can help consumers understand, interpret, and manage their scores. So read on:

www.clevelandfed.org/research/Commentary/2010/2010-16.pdf

Addressing the Impact of the Foreclosure Crisis (FRB Press release)

2010-10-27T11:40:00.001-04:00

A new publication, Addressing the Impact of the Foreclosure Crisis, details the innovative, community-based foreclosure prevention and neighborhood stabilization activities sponsored by the Federal Reserve as part of its Mortgage Outreach and Research Efforts (MORE) initiative.

The presidents of the 12 Federal Reserve Banks worked collaboratively with the Board of Governors to launch MORE in 2009. The initiative seeks to employ the Federal Reserve System's substantial expertise in mortgage markets in ways that are useful to policymakers, community organizations, financial institutions, and the public.

Highlights of the MORE group's work include bringing together housing advocates, lenders, academics, and key government officials to discuss foreclosure issues and develop solutions; partnering with the U.S. Departments of Labor and Treasury and the HOPE NOW Unemployment Task Force to assist unemployed homeowners at risk of losing their homes to foreclosure; developing online Foreclosure Resource Centers at each Reserve Bank and the Board of Governors; and sponsoring and distributing research on the foreclosure crisis, including studies on financial literacy and foreclosure prevention.

Additional information about the System's MORE activities is available in the online version of Addressing the Impact of the Foreclosure Crisis.

A Review of Statistical Problems in the Measurement of Mortgage Market Discrimination and Credit Risk

2010-10-13T10:00:00.000-04:00

By Anthony M. Yezer

Abstract: This paper examines the fundamental assumptions within the statistical analysis of discrimination and credit risk and the impact these flawed models had on the mortgage market ranging from false findings of discrimination to incorrectly detecting the future rise of default rates. Serving as a valuable resource to identify the flaws that continue to be overlooked in today's analyses, the paper promotes the improvement of the measurement of mortgage market discrimination and credit risk for a more accurate assessment.

Download here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1684216

Collateral Risk in Residential Mortgage Defaults

2010-10-13T09:58:00.000-04:00

By Tyler T. Yang, Che-Chun Lin and Man Cho

Forthcoming in the Journal of Real Estate Finance and Economics

Abstract: This paper presents a systematic framework for capturing the collateral-driven mortgage default risk. A forward-looking home price distribution model is developed that explicitly incorporates different sources of volatility in the market value of collateral houses. A consistent and computationally-efficient top-down approach of home price simulation is also introduced. We show that with the proper inclusion of all relevant sources of volatilities, the top-down approach provides close approximation to the results generated by a theoretically sound but computationally demanding bottom-up simulation approach. Using a numerical simulation, we demonstrate that a geographically-diversified mortgage pool entails a substantially lower level of systematic collateral driven mortgage default risk compared to a spatially-concentrated pool. However, the expected default risk is shown to remain unaffected, indicating that the benefit from geographic diversification is only realized through lower risk-based capital requirements, not in lower mortgage insurance premiums. Based on the US state level house price indices, the systematic risk of a state-concentrated mortgage pool is estimated to be about four times higher than that of a nationally-diversified mortgage pool. Our results also show that, among the different volatility components, omitting the cross-sectional dispersion of individual home prices would produce the largest bias in assessing home-price-based mortgage default risk.

For more see: papers.ssrn.com/sol3/papers.cfm?abstract_id=1684611

Primers on "Foreclosuregate" (Update 1)

2010-10-11T21:58:00.003-04:00

There are a number of great primers on the current mortgage mess. Here are some of them, starting with Rortybomb's multiparter that gets down into the real nitty gritties:

Foreclosure Fraud for Dummies 1: The Chains and Stakes
Foreclosure Fraud for Dummies 2: What is a Note and Why is it So Important?
Foreclosure Fraud for Dummies 3: Why Are Servicers So Bad At Their Job?
Foreclosure Fraud for Dummies 4: How Could This Explode Into A Systemic Crisis?
Underwater and the Strategic Default PR Campaign: What we got when we didn’t get cramdown?

There's also John Carny's primer at CNBC.com:

A Primer On The Foreclosure Crisis

There's also some good stuff on the Credit Slips blog:

And finally Felix Salmon's take on SIFMA's take:
SIFMA's Unhelpful Take on the Foreclosure Mess

Moratorium for What? (Alan White on Credit Slips)

2010-10-11T13:10:00.001-04:00

Originally posted on Credit Slips:

There is little to be accomplished by halting foreclosures and sales in process without some plan resolve the 5 million seriously delinquent mortgages other than by foreclosure sale. While something can be said for delays that stretch out the process of dumping more unsold homes into a saturated existing homes inventory, we are only about one-third of the way through the crisis at present (having foreclosed or forced the sale about two to three million homes since 2007). If a moratorium is to do some good, it has to result in diverting some foreclosures to better resolutions.

The two most attractive alternatives, refinancing and modification, seem to have failed already. The Administration’s HARP and HAMP programs continue to post disappointing numbers. In light of HAMP’s failure, I am asked frequently, what should we replace it with? Unfortunately there really are no other, better solutions. We can either dump another 12 to 24 months’ supply of homes on the resale market, or modify enough mortgages to make a difference. Treasury must either enforce its HAMP contracts with the banks, or fire the current servicers and transfer distressed mortgages to servicers who can do the job properly.

Modifications have not succeeded in bringing down the 5 million distressed mortgages number in part because of the massive failure of the big banks to do their jobs. In the present context, their job is to rework existing mortgages so homeowners can repay them. Modified mortgages that reduce payments are now succeeding at a rate of 65% to 75%, compared with 40% for 2007 and 2008 modifications, which typically increased or deferred payments. We know from Treasury’s monthly reports that a homeowner’s chances of getting a temporary modification, converting to a permanent modification, and getting timely action at those two stages depends hugely on which bank or servicer handles their mortgage. The variances in HAMP performance are appalling, and are clear proof that far more could be done than is being done to divert distressed mortgages out of foreclosure.

The case for modifications gets stronger every month, not only because redefault rates are declining, but because the two other key variables in the economics of foreclosure vs. modification are steadily worsening. The rate at which unmodified defaulted mortgages fix themselves, the self-cure rate, has declined from 5% or more per month to less than 1% per month (foreclosure roll rate Charts tab). Loss severities, the percentage of mortgage balances not recovered at foreclosure sales, continue to rise, and are now in the 60% range. What this all means is that even a mortgage modification that was uneconomical a year ago might be net present value positive today.

Proposals to refinance all existing Fannie and Freddie mortgages to take advantage of low interest rates and reduce payment burdens are fundamentally equivalent to across-the-board modification of those mortgages. From the homeowner’s perspective, it makes no difference whether her existing mortgage is converted to a 4% fixed rate and stretched out to 30 more years, or it is refinanced with a new, 4% fixed rate 30-year mortgage. For the economy, the refinancing program produces a few more transaction costs that will create a few jobs for title clerks and document processors, but that hardly justifies the additional debt that refinancing necessarily creates. The point is to reduce America’s home debt, not to keep postponing it.

An Analysis of Government Guarantees and the Functioning of Asset-Backed Securities Markets

2010-09-28T10:36:00.002-04:00

By Diana Hancock and Wayne Passmore (Federal Reserve Board)

Abstract: Mortgage securitization has been tried several times in the United States and each time it has failed amid a credit bust. In what is now a familiar recurring history, during the credit boom, underwriting standards are violated and guarantees are inadequately funded; subsequently, defaults increase and investors in mortgage-backed securities attempt to dump their investments.

We focus on a specific market failure associated with asset-backed securitization and propose a tailored government remedy. Our analysis of loan market equilibriums shows that the additional liquidity provided by securitization may (or may not) lower primary loan rates, but such liquidity comes at a cost. More specifically, if guarantee-sensitive investors doubt the credit quality of asset-backed bonds, significant risk premiums can develop. If a financial crisis ensues, securitization can disappear from the market entirely, leaving banks that originate just the highest quality loans as the only source of credit. This abrupt increase in lending standards can tighten credit, exacerbate asset price declines, and impinge on economic growth.

We argue that an institutional structure for stemming "runs," analogous to the current set up for the Federal Deposit Insurance Corporation, could be deployed to insure pre-specified asset-backed instruments. Such an insurer would likely benefit from the accumulated information and infrastructure that is embodied in Fannie Mae and Freddie Mac. Hence, the provision of federally-backed catastrophic insurance could provide a rationale for restructuring the housing-related GSEs towards a public purpose. Regardless of its institutional structure, a federally-backed catastrophic bond insurer would provide greater financial stability and ensure credit is provided at reasonable cost both in times of prosperity and during downturns. Moreover, the explicit pricing of the government-backed guarantee would mitigate the market distortions that have been created by implicit government guarantees during prosperity.

Download here: www.federalreserve.gov/pubs/feds/2010/201046/201046abs.html

See critical comment from Seeking Alpha:

Now, I know what you are probably thinking--this sounds pretty good, but what happens ~~when~~ if this bond insurer gets into financial problems (like what happened to Fannie Mae). Won't the market panic when they see that the bond insurer cannot fulfill all of its obligations? Don't worry; the sagacious PhDs at the Fed have a plan for this eventuality: an explicit government guarantee for the bond insurer and all of its obligations. That's right; taxpayers are on the hook for all losses suffered the bond insurer. The authors argue that an implicit guarantee is not enough to prevent a "run" on the securitization market because it still leaves doubt in the market.

But you should not concern yourself too much, because the bond insurer would apply prudent risk management to its portfolio and charge market rate premiums. The paper acknowledges that "in essence the government provides the risk management and market discipline that retail investors cannot provide." For those of you who question the premise that government knows best the authors are quick to counter that:

Moreover, such an insurer would likely benefit from the accumulated information on mortgage default, credit risk modeling expertise, and the securitization know how and infrastructure (e.g., work-out processes and other real estate owned management) that is embodied in the Fannie Mae and Freddie Mac organizations.

If you are not laughing on the floor out loud after reading this, then you are good little government trusting slaves. Fannie and Freddie (FMCC.OB) dramatically under priced risk despite their insider knowledge of the mortgage market. Furthermore, the two government wards failed to see the folly in using 100-1 leverage. And to top it off, these two institutions were routinely audited and supervised by the Office of Federal Housing Enterprise Oversight (OFHEO). These clowns signed off on Fannie Mae's books and missed a large accounting fraud, estimated at over $9 billion.

If the authors have their way. this new entity will not have to put up with very much congressional oversight. The legal status of this new, bond insurer would be structured as an independent agency within government and would have a line of credit with the Treasury (similar to the FDIC) to cover catastrophic losses. Coincidentally, this is the same legal status as the Federal Reserve.

The paper goes on to mention the benefit of a new bond insurer for financial institutions (I love how the government is always looking out for the banks) because it would allow them to adequately hedge their risk by purchasing insurance on their asset backed securities. Another advantage is that the bond insurer would guarantee debt issued by financial institutions as long as the debt was backed by an ABS. The idea is that as long as the government is explicitly guaranteeing these assets, banks should not have a problem issuing ABS or bank debt during financial panics. After all, you are backed by the full faith and credit of the American ~~tax slave~~ taxpayer. Another benefit of this new scheme is that it gives the Federal Reserve another potential asset to buy during liquidity crises.

I don't know about you, but after hearing this preposterous idea, my head is hurting. It could be that since I am not a classically trained PhD in Economics. I simply cannot understand the inherent rationale of this proposal. To me, this paper is suggesting that the US taxpayer provide a complete guarantee to the entire asset backed security market. This scares the living daylights out of me because we just witnessed the collapse of Fannie Mae and Freddie Mac, which has cost the US taxpayer hundreds of billions of dollars.

I realize that we should not be too concerned about the cost of these bailouts because we print money, but this idea sets up a large future liability to taxpayers when the ABS market blows up again. Another problem I have with this idea is that it amounts to another bailout for the financial industry and will create an unimaginable amount of moral hazard. Banks will quickly get the idea that they can originate almost any asset, regardless of its credit quality because the government will always guarantee it. Fraud will be rampant as institutions lie about asset quality in order to be eligible for government insurance.

I know the authors would counter that the bond insurer would have high credit standards and would not insure risky collateral. To answer this I submit to you Fannie Mae and Freddie Mac. These two institutions said the same thing about the credit quality of their portfolios, and look what happened.

As it turned out, Fannie Mae and Freddie Mac had dramatically underestimated the real risks contained in their portfolios. Risk management is very imprecise and subject to large errors, depending on economic conditions. I have no faith that this new bond insurer would be any better at managing risk in the ABS market than Fannie Mae did in the mortgage market. While I do not like the idea of a taxpayer backed bond insurer with an explicit government guarantee, the concept would make an interesting economic experiment.

Can there be a financial panic if the government guarantees all financial assets and prints money to fulfill its obligations?

A Third of Public Says It’s Sometimes OK for Homeowners to Stop Making Mortgage Payments

2010-09-17T10:24:00.001-04:00

According to a recent Pew Research report:

A majority of Americans say it is "unacceptable" for homeowners to stop making their mortgage payments and abandon their homes, according to a Pew Research Center survey. But more than a third (36%) say the practice of "walking away" from a home mortgage is acceptable, at least under certain circumstances.

The full report can be downloaded here.

Underwater Solution: Value Gap Refinance - HSH.com

2010-09-09T07:18:00.001-04:00

Keith Gumbinger, a vice president at the HSH Associates mortgage consulting firm, wants the federal government to issue "value gap coverage." It would reduce underwater homeowner interest payments, and reduce the incentive to walk:

In the present economic climate, it's getting harder for millions of people who want to remain responsible homeowners. Frankly, as things stand now, there's little financial incentive for them to continue to behave responsibly, and plenty of potential benefit should they decide to behave badly.

Here's why. Economic and market conditions beyond anyone's control have eroded home values. As a result, far too many people are trapped in homes worth less than the mortgage amount they borrowed. Although there have been some half-hearted solutions proposed (including such notables as the Home Affordable Refinance Program, or HARP), very few underwater but honorable homeowners will get any help in alleviating their budgetary stress. For the majority of homeowners who are current but "underwater" and so cannot refinance, there are no programs available from either the private market or the government to help.

Although no assistance is coming your way, you're being asked to "step up" to help "less fortunate" homeowners get "affordable" loans, and you're expected to cover the costs of bailing out Wall Street, megabanks, General Motors. You are even being asked to backstop Fannie Mae and Freddie Mac, the now-taxpayer-backed firms that own or guarantee mortgages. As time goes on, it's increasingly clear that the "reward" for doing the right thing and paying your obligations faithfully and on time will come not in the form of any support, but rather huge future tax bills.

You know that the Federal government's involvement in the housing market crisis has been deep and wide. What you might not know is that it is probably insufficient.

Low mortgage rates have proven to be little more than a beautiful mirage to homeowners who have no equity in their homes or who are underwater. If you're one of them, you cannot refinance to recast your household balance sheet and cannot sell without generating a loss, some (or all) of which you will need to pay out of pocket.

It has also become increasingly apparent that before the housing market and the broader economy can move forward, new solutions to the "underwater" issue must be considered. If we are going to spend billions of taxpayer dollars to keep people in homes they cannot afford, shouldn't we also consider some form of program for people who want to remain in their homes and behave honorably, but who -- through no fault of their own -- cannot take advantage of the lowest mortgage rates in more than 50 years, and are missing perhaps the best chance ever to lighten their financial burden?

The idea of widespread "principal reduction" continues to be floated in the market, most recently when a rumor circulated that Fannie Mae would begin such a program at the direction of the administration. While it was probably only a trial balloon to test market reaction, millions of homeowners remain trapped in loans that exceed the value of their homes and who could benefit greatly from the kind of budgetary improvement that mortgage refinancing provides.

It's our opinion that the failure to develop any response to this "underwater and can't refinance" problem exacerbates the "strategic default" problem and also likely ensures that the issue of lender loss via "short sale" will be with us for many years to come.

We've taken some time to more deeply consider the "underwater and can't refinance" problem and think we've got a practical solution for many people trapped in this situation. It goes without saying that not all borrowers can be made whole through any government program, but at least some can. Our "value-to-price gap coverage" ("value gap coverage") concept would be aimed solely at borrowers who are still current on their mortgages, have every intention of remaining so and hope to remain in their homes for the foreseeable future.

Perhaps the most controversial idea in what follows is that we absolve the borrower of responsibility for any deficiency. If a borrower did not cause a decline in his or her home's value, has been meeting his or her obligations without fail and is now, outrageously, being asked to pick up part of the tab for failed homeowners, he or she ought to get some subsidized benefit for doing the right thing. If it works, there would be a declining cost to the taxpayer over time, with the actual cost of "assistance" possibly falling to zero.

An Idea: Government-Sponsored Value Gap Coverage

No borrower obligation for shortfall or deficiency
We'll start with the simple but controversial premise: At no time will the homeowner be responsible for any deficiency between the value of the home and the dollar amount of the mortgage, at least based upon today's valuations. (An alternate plan, included below, allows for some homeowner participation; continue reading to see how).

Since there is no equity in the home, the refinance will of course not allow the homeowner to take any cash out of the property.

Establishing a "value gap"
Using the current mortgage balance, and weighed against a fresh appraisal of the property, a "value gap" would be established and registered with a government entity, most likely HUD but possibly Fannie Mae or Freddie Mac.

Deferred payment to lender or investor
A "value gap contract" would be executed between the lender/investor and the government entity to cover this differential. This payment would not be made today, but rather deferred to when the property has been sold to another party. As well, this contract's dollar amount (coverage) could be expanded to cover any mortgage insurance needs; this additional premium could be paid into a self-insuring pool or lender-paid MI arrangement.

Refinance particulars
Under this arrangement, the borrower would refinance 100 percent of the present appraised value of the home. This would produce a new mortgage at a 100 percent loan-to-value (LTV) ratio at today's market interest rates, and the refinance would come in the form of a fixed-rate, fully amortizing mortgage with a 30-year term. If the borrower's financials permit them to handle a shorter term, they would be allowed to choose one.

Here's an example:

- Value of mortgage: $180,000

- Value of home: $150,000

- Value gap: $30,000 (about 17 percent "underwater")

- Refinance at 100 percent LTV: $150,000 (plus needed MI coverage, if any).

Lender's benefit
At the time of the loan's origination, lenders or investors would get no additional cash but rather a guarantee that should a deficiency still occur when the property sells in the future, they will be made whole by the government for this established value gap. To produce incentives to participate, and to help ensure fair return, the same market rate for the refinance mortgage should be applied to the value gap contract, so the investor would receive just as much as any fully refinanced loan amount would bring ($180,000 per our example). This interest cost could be borne by the borrower, just as the mortgage interest cost would be.

Government costs decline over time
As time goes on, and home prices eventually recover, the amount of the value gap contract would diminish. This change of the contract value amount would happen at the time an appraisal was conducted in preparation for the home to be sold to another party.

For example, let's say that the home was sold 12 months after a "value gap refinance." If the home's value has appreciated by 3 percent in the year after the value gap refinance was executed, the value of the home would have improved to $154,500. The full proceeds from the sale -- $154,500 -- would be paid to the investor; because the value gap was made smaller by market appreciation, the dollar amount of the value gap coverage would be reduced by a like amount. As such, the value gap contract holder (government) would be responsible to make up a differential of just $25,500.

Borrower's benefit
In exchange for the ability to refinance to a new mortgage with a lower face amount and a present-market interest rate, the borrower gives up rights to future appreciation -- but not forever. Any price appreciation would be committed to the value gap until such time as the value of the home once again exceeds the value of the original mortgage (per the example above, $180,000). The borrower would not be responsible for any shortfall, but only for interest payments on the amount of the shortfall.

That is, the borrower would not benefit from any market-based appreciation until the value gap is filled and the liability to the government satisfied. In the example above, the homeowner would develop equity in the property only from the retirement of principal through regular repayment of the loan and not from market appreciation until the value of the home exceeds the original face loan amount.

Creating equity
However, homeowners would create a new equity stake in the traditional manner: by paying down their loan balance though regular amortization. As the borrower slowly retires the outstanding balance of the loan amount created at the time the value gap was established (a refinanced $150,000 per our example), the declining loan balance produces equity in the normal fashion. This of course becomes the borrower's equity stake, free and clear of any obligation.

Should the homeowner hold onto the property for an extended period of time before selling, and should the value gap be eliminated, any amount of money in excess of the original loan amount is the homeowner's, free and clear of any obligation.

Most likely, this would take place over a number of years. Assuming a 3 percent per-year increase in the home's value owing to market appreciation, the calculation would look something like this:

Value Gap Coverage Example
Home value: $150,000; Original Loan Value $180,000; Value Gap $30,000
(Assumes 4.5% Loan Rate)	Home Value $150,000	Value Gap $30,000	Mortgage Amount $150,000	Equity Stake $ --	Equity Accrued From
After 1 yr	$154,500	$25,500	$147,580	$ 2,420	mortgage
After 2 yrs	$159,135	$20,865	$145,049	$ 4,951	mortgage
After 3 yrs	$163,909	$16,091	$142,402	$ 7,598	mortgage
After 4 yrs	$168,826	$11,174	$139,633	$10,367	mortgage
After 5 yrs	$173,891	$ 6,109	$136,737	$13,263	mortgage
After 6 yrs	$179,107	$ 893	$133,708	$16,292	mortgage
After 7 yrs	$184,481	-$ 4,481	$130,539	$23,942	mortgage+appr

Shared obligation plan
Do you find the idea of a homeowner getting a free ride for many thousands of dollars in debt to be unpalatable? We thought you might, so here's an alternative arrangement, familiar to anyone with a private mortgage insurance policy:

An alternate to this plan above would be to give the borrower an interest rate that is perhaps a half percentage point above market. They would still receive substantial benefit from the contract's coverage and the refinance but have some obligation toward the deficit.

Under this scenario, the lender would get the market rate (4.5 percent, as above) for the mortgage; the borrower would make payments as though the rate was 5 percent (very similar to the effect of private mortgage insurance as it relates to the cost of a loan).

This "fee" -- the monthly payment increase generated by the half-percentage point interest rate differential -- would be used to reduce the government outlay. With the values used above of $150K, $180K and a $30K value gap coverage, the table above would look like this:

Value Gap Coverage Shared Obligation
(Assumes 4.5% Loan Rate)	Home Value $150,000	Value Gap $30,000	Less 0.5% Fee	New Value Gap	Mortgage Amount $150,000	Equity Stake $ --	Equity Accrued From
After 1 yr	$154,500	$25,500	$543	$24,957	$147,580	$ 2,420	mortgage
After 2 yrs	$159,135	$20,865	$543	$20,332	$145,049	$ 4,951	mortgage
After 3 yrs	$163,909	$16,091	$543	$15,548	$142,402	$ 7,598	mortgage
After 4 yrs	$168,826	$11,174	$543	$10,631	$139,633	$10,367	mortgage
After 5 yrs	$173,891	$ 6,109	$543	$ 5,566	$136,737	$13,263	mortgage
After 6 yrs	$179,107	$ 893	$543	$ 350	$133,708	$16,292	mortgage
After 7 yrs	$184,481	-$ 4,481	$ -	$ -	$130,539	$23,942	mortgage+appr

As a result, the borrower would kick in as much as $3,258 over the six-year period to help reduce the value gap coverage and lower the cost to the taxpayer.

Program limits?
If desired, this program could have income limits, but could still be structured so that even homeowners with jumbo mortgages could buy in (for a proportionally higher fee); it could have dollar amount or value-gap percentage limits; it could be limited to only those folks who bought homes in a given range of years (say, 2003-2008); and even the 0.5 percent fee above could be scaled or adjusted to compensate for larger or smaller gaps.

Solving problems
The benefits of participation for lenders or investors are many. In today's difficult market, the incidence of borrowers executing "strategic default" continues to grow. These "walk-aways" can be tremendously costly to the investor as tens of thousands of dollars will likely be spent in the foreclosure process. For all that, the property will still likely be disposed of at the kind of market price described above ($150,000), so the loss to the investor might be quite severe.

A value-gap coverage program provides borrowers with a more compelling reason to remain in their homes -- a disincentive to walking away. It also alleviates the stressful short-sale process, leaving borrowers free to sell their homes at a value their markets will support. It can also allow for greater mobility... the kind of mobility that may allow a homeowner to pick up stakes and pursue a better job in another locale. The change in a homeowner's cash flow can also provide meaningful budgetary relief, which in turn could support some additional consumer spending beyond simple necessities, providing a lift to the economy. In addition, it might even be a spark to improve consumer moods, another key to getting the recession's effects behind us.

As for the taxpayer's role, the government is already deeply involved in housing, in everything from foreclosure-prevention programs, to loan modifications, to subsidized jumbo mortgages backed by FHA or Fannie and Freddie. All have shown limited success, no doubt in part to the highly targeted nature of these groups of homeowners. Unlike present programs, the cost to the government would be known and absolute, established right up front, and would likely diminish -- perhaps disappear -- as time rolls forward.

There are no cheap or easy solutions to some of today's difficult mortgage and housing market problems. There have been many initiatives and programs to help foster and preserve homeownership, almost all aimed at borrowers who have already failed or who are likely to fail. It may be time to consider a program to fill in the giant equity hole that has appeared for so many homeowners, which will require unconventional ideas to address these issues. We think the above might just be one of those ideas.

Where Does the Mortgage Market Go from Here?

2010-08-30T12:45:00.000-04:00

Original posted on the Cleveland Fed website:

In the first quarter of 2010, it appeared that the mortgage market was running out of steam. An increase in mortgage originations in the second quarter, however, demonstrates that there still is demand for mortgages. According to Inside Mortgage Finance, VA-mortgage originations increased 6.3 percent from the first to the second quarter, originations from the top 25 lenders were up 7.6 percent over the same period, and total originations were up 6.3 percent. In addition, new private mortgage insurance was up 26.6 percent over last quarter. Private mortgage insurance is extra insurance lenders require when the amount of a loan exceeds 80 percent of the home’s value. The increased availability of this type of insurance could make home ownership more accessible to homeowners who don’t have enough for a 20 percent down payment.

According to a recent survey published in Inside Mortgage Finance, the improved second-quarter performance was driven by consumers taking advantage of the favorable interest rate environment and the extension of the homebuyer tax credit. Since October 2008, interest rates on 30-year fixed mortgages have fallen 155 basis points, from 6.39 percent to 4.84 percent. In addition to the favorable rates, many homebuyers decided to take advantage of the homebuyer tax credit, which gave first-time homebuyers a tax deduction of $8,000 and existing homeowners buying a new home a deduction of $6,500. The credit, which was set to expire in November 2009, was extended until April 2010.

While the second-quarter originations provide a glimmer of hope that the housing market is improving, significant challenges still lay ahead. This is evident when examining the number of delinquent mortgages, new foreclosures, and the inventory of foreclosures. Between March 2003 and June 2010, the number of delinquent loans increased from 1.6 million to nearly 4.4 million. Rising even more dramatically is the inventory of foreclosed homes, which increased from 482 thousand to slightly over 2.0 million. As of June 2010, 6.9 million loans are classified as in trouble.

The difficulties involved in attempting to rectify the imbalances in the housing market can be demonstrated by examining the July Home Affordability Modification Program (“HAMP”) Servicer Performance Report. According to the report, even though nearly 3.1 million delinquent loans were eligible for modification and 1.3 million modification trials have been started since May 2009, the number of permanent modifications started since September of 2009 has been a mere 434 thousand. Given that there are currently 4.4 million delinquent borrowers and only 434 thousand permanent modifications in the works, it is likely that the real estate market will remain fragile for some time.

Canada’s Very Own Mortgage Mess: The Laws and Programs Behind a National Dilemma

2010-08-30T07:40:00.001-04:00

By Nathan Hume, University of Toronto - Faculty of Law

Abstract: Canadian house prices require explanation. Despite a deep global recession and persistent credit crisis, they remain near record highs while prices elsewhere have plummeted. This article offers an institutional account of that anomaly. The insurance and securitization programs of the Canada Mortgage and Housing Corporation have insulated the Canadian mortgage and housing markets from recent turbulence. These large, unfamiliar programs also distort and may ultimately destabilize the Canadian economy. Arguments about asset bubbles are unproductive. This article explains these programs, their effects and their legal framework so that we can better discuss what to do with them.

Download here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1654340

Redefault Rates on Loan Modifications Improving Says State Foreclosure Prevention Working Group

2010-08-28T08:21:00.000-04:00

Washington, DC—According to a report issued today by the State Foreclosure Prevention Working Group, increased use of loan modifications resulting in significant payment reduction has succeeded in creating more sustainable loan modifications. The number of foreclosures continues to outpace the number of loan modifications being made, but there are reasons to be optimistic about the improvement in loan modification performance. The State Working Group’s data indicate that some recent modifications are performing better than loan modifications made earlier in the mortgage crisis.

In addition, the State Working Group found that modifications which significantly reduce the capital balance of the loan have a lower rate of redefault compared to loan modifications overall. Currently, however, only one in five loan modifications reduce the loan amount, and the vast majority of loan modifications actually increase the loan amount by adding servicing charges and late payments to the loan balance.

Despite these positive developments, the numbers of foreclosures continue to far outpace the number of loan modifications. The State Working Group finds that more than 60% of homeowners with serious delinquent loans are still not involved in any loss mitigation activity. Absent additional improvements in foreclosure prevention efforts, the State Working Group anticipates hundreds of thousands of foreclosures will occur later this year.

“The report certainly indicates there are positive developments with regard to loan modifications,” said Neil Milner, President and CEO of the Conference of State Bank Supervisors. “However, there is still a tremendous amount of work to be done to prevent unnecessary foreclosures. Servicers must continue to perform meaningful outreach to those homeowners who are seriously delinquent and to perform modifications with significant principal reduction.”

The State Foreclosure Prevention Working Group, which consists of 12 state attorneys general (AZ, CA, CO, FL, IL, IA, MA, NV, NC, OH, TX, WA), bank regulators for NY, NC, and MD, and the Conference of State Bank Supervisors, was founded in 2007 and has issued four prior reports. View the reports.

FHFA Releases First Conservator’s Report on the Enterprises’ Financial Condition

2010-08-27T07:34:00.001-04:00

Washington, DC - August 26, 2010 - The Federal Housing Finance Agency (FHFA) today released its first Conservator’s Report on the Enterprises’ Financial Condition. The Conservator’s Report provides an overview of key aspects of the financial condition of Fannie Mae and Freddie Mac (the Enterprises) during conservatorship. The report will be released on a quarterly basis following the filing of the Enterprises’ financial results with the Securities and Exchange Commission (SEC).

“FHFA initiated the Conservator’s Report to enhance public understanding of Fannie Mae’s and Freddie Mac’s financial performance and condition leading up to and during conservatorship,” said FHFA Acting Director Edward J. DeMarco.

The report includes information on Enterprise presence in the mortgage market; credit quality of Enterprise mortgage purchases; sources of Enterprise losses and capital reductions; and Enterprise loss mitigation activity. Information presented in the report includes:

• The key driver in the decline of the Enterprises’ capital from the end of 2007 through the second quarter of 2010 was the Single-Family Credit Guarantee business segment, which accounted for 73 percent of the capital reduction over that period. The bulk of this capital reduction was associated with losses from mortgages originated in 2006 and 2007.
• The Investments and Capital Markets business segment (which includes the retained portfolio and credit losses associated with private-label mortgage-backed securities) accounted for 9 percent of the capital reduction over the same period.
• Since the establishment of the conservatorships, the credit quality of the Enterprises’ new mortgage acquisitions has improved substantially. Single-family mortgages acquired by the Enterprises during conservatorship have, on average, higher credit scores and lower loanto- value ratios, resulting in lower early cumulative default rates.

Download the full report here: www.fhfa.gov/webfiles/16591/ConservatorsRpt82610.pdf

A Private Lender Cooperative Model for Residential Mortgage Finance

2010-08-06T17:29:00.001-04:00

Authors: Toni Dechario, Patricia Mosser, Joseph Tracy, James Vickery, and Joshua Wright

Abstract: We describe a set of six design principles for the reorganization of the U.S. housing finance system and apply them to one model for replacing Fannie Mae and Freddie Mac that has so far received frequent mention but little sustained analysis – the lender cooperative utility. We discuss the pros and cons of such a model and propose a method for organizing participation in a mutual loss pool and an explicit, priced government insurance mechanism. We also discuss how these principles and this model are consistent with preserving the “to-be-announced,” or TBA, market – particularly if the fixed-rate mortgage remains a focus of public policy.

Download here: http://www.newyorkfed.org/research/staff_reports/sr466.html

Obesity and Mortgage Delinquencies

2010-07-13T08:00:00.001-04:00

By Katherine Guthrie and Jan Sokolowsky

Abstract: We show that obesity is an economically significant predictor of mortgage delinquencies at the county level. In practice, however, loan contracts do not incorporate easily verifiable health risk factors such as obesity. The discrepancy between theory and practice suggests the existence of substantial cross-subsidization and misallocation of funds in the loan market. The potential for business opportunities and policy implications warrants further investigation of our results with more detailed, albeit costly data.

Download here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1617484

Strategic defaults remain high, but relief may be in sight

2010-07-03T14:37:00.001-04:00

According to the new Experian–Oliver Wyman Market Intelligence Report, strategic defaults continued as a high percentage of all mortgage delinquencies at 19 percent in the second quarter of 2009. While, overall, the broad trends observed in the first Experian–Oliver Wyman Market Intelligence Report on Strategic Defaults have continued into 2009, there is reason to believe the phenomenon may have peaked, or be close to peaking.

Download the complete press release here: www.oliverwyman.com/ow/pdf_files/OW_EN_FS_2010_Press_ExperianOW_Strategic_Defaults.pdf

U.S. GAO: Further Actions Needed to Fully and Equitably Implement Foreclosure Mitigation Programs

2010-07-02T09:42:00.003-04:00

Congress created the Troubled Asset Relief Program (TARP) to, among other things, preserve homeownership and protect home values. In March 2009, the U.S. Department of the Treasury (Treasury) announced the Home Affordable Modification Program (HAMP) as its cornerstone effort to achieve these goals. This report examines (1) the extent to which HAMP servicers have treated borrowers consistently and (2) the actions that Treasury has taken to address the challenges of trial modification conversions, negative equity, redefaults, and program stability. GAO obtained information from 10 servicers that account for 71 percent of HAMP funds and spoke with Treasury, Fannie Mae, and Freddie Mac officials.

While one of Treasury's stated goals for HAMP was to standardize the loan modification process across the servicing industry, GAO found inconsistencies in how servicers were treating borrowers under HAMP that could lead to inequitable treatment of similarly situated borrowers. First, because Treasury did not issue guidelines for soliciting borrowers for HAMP until a year after announcing the program, servicers notified borrowers about HAMP anywhere from 31 days to more than 60 days after a delinquency. Many borrowers also complained that they did not receive timely responses to their HAMP applications and had difficulty obtaining information about the program. Treasury has recently issued guidelines on borrower communications, and plans to monitor compliance with the guidelines. Second, Treasury has emphasized the importance of reaching borrowers before they are delinquent but has not issued guidelines for determining when borrowers are in imminent danger of default. As a result, the 10 servicers that GAO contacted reported 7 different sets of criteria for determining imminent default. Third, while Treasury required servicers to have internal quality assurance procedures to ensure compliance with HAMP requirements, Treasury did not specify how loan files should be sampled for review or what the reviews should contain. As a result, some servicers did not review trial modifications or HAMP denials as part of their quality assurance procedures. Fourth, Treasury has not specified which HAMP complaints should be tracked, and several servicers track only certain types of complaints. Fifth, Treasury has not clearly informed borrowers that the HOPE Hotline can be used to raise concerns about servicers' handling of HAMP loan modifications and to challenge potentially incorrect denials, likely limiting the number of borrowers who have used the hotline for these purposes. Finally, Treasury does not have clear consequences for servicers that do not comply with program requirements, potentially leading to inconsistencies in how instances of noncompliance are handled.

For links to the full reports: http://www.gao.gov/products/GAO-10-634

Recommendations for Executive Action

Recommendation: As part of its efforts to continue improving the transparency and accountability of HAMP, the Secretary of the Treasury should expeditiously establish clear and specific criteria for determining whether a borrower is in imminent default to ensure greater consistency across servicers.

Agency Affected: Department of the Treasury

Status: In process

Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

Recommendation: As part of its efforts to continue improving the transparency and accountability of HAMP, the Secretary of the Treasury should expeditiously develop additional guidance for servicers on their quality assurance programs for HAMP, including greater specificity on how to categorize loans for sampling and what servicers should be evaluating in their reviews.

Agency Affected: Department of the Treasury

Status: In process

Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

Recommendation: As part of its efforts to continue improving the transparency and accountability of HAMP, the Secretary of the Treasury should expeditiously specify which complaints servicers should track to ensure consistency and to facilitate program oversight and compliance.

Agency Affected: Department of the Treasury

Status: In process

Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

Recommendation: As part of its efforts to continue improving the transparency and accountability of HAMP, the Secretary of the Treasury should expeditiously more clearly inform borrowers that the HOPE Hotline may also be used if they are having difficulty with their HAMP application or servicer or feel that they have been incorrectly denied HAMP, monitor the effectiveness of the HOPE Hotline as an escalation process for handling borrower concerns about potentially incorrect HAMP denials, and develop an improved escalation mechanism if the HOPE Hotline is not sufficiently effective.

Agency Affected: Department of the Treasury

Status: In process

Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

Recommendation: As part of its efforts to continue improving the transparency and accountability of HAMP, the Secretary of the Treasury should expeditiously finalize and issue consequences for servicer noncompliance with HAMP requirements as soon as possible.

Agency Affected: Department of the Treasury

Status: In process

Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

Recommendation: As part of its efforts to continue improving the transparency and accountability of HAMP, the Secretary of the Treasury should expeditiously report activity under the principal reduction program, including the extent to which servicers determined that principal reduction was beneficial to investors but did not offer it, to ensure transparency in the implementation of this program feature across servicers.

Agency Affected: Department of the Treasury

Status: In process

Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

Recommendation: As part of its efforts to continue improving the transparency and accountability of HAMP, the Secretary of the Treasury should expeditiously finalize and implement benchmarks for performance measures under the first-lien modification program, as well as develop measures and benchmarks for the recently announced HAMP-funded homeowner assistance programs.

Agency Affected: Department of the Treasury

Status: In process

Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

Recommendation: As part of its efforts to continue improving the transparency and accountability of HAMP, the Secretary of the Treasury should expeditiously implement a prudent design for remaining HAMP-funded programs.

Agency Affected: Department of the Treasury

Status: In process

Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

Fed: The Depth of Negative Equity and Mortgage Default Decisions

2010-06-24T07:36:00.001-04:00

Abstract: A central question in the literature on mortgage default is at what point underwater homeowners walk away from their homes even if they can afford to pay. We study borrowers from Arizona, California, Florida, and Nevada who purchased homes in 2006 using non-prime mortgages with 100 percent financing. Almost 80 percent of these borrowers default by the end of the observation period in September 2009. After distinguishing between defaults induced by job losses and other income shocks from those induced purely by negative equity, we find that the median borrower does not strategically default until equity falls to -62 percent of their home's value. This result suggests that borrowers face high default and transaction costs. Our estimates show that about 80 percent of defaults in our sample are the result of income shocks combined with negative equity. However, when equity falls below -50 percent, half of the defaults are driven purely by negative equity. Therefore, our findings lend support to both the "double-trigger" theory of default and the view that mortgage borrowers exercise the implicit put option when it is in their interest.

Download at: www.federalreserve.gov/pubs/feds/2010/201035/201035pap.pdf

Fannie Mae Increases Penalties for Borrowers Who Walk Away

2010-06-23T22:00:00.001-04:00

WASHINGTON, DC — Fannie Mae (FNM/NYSE) announced today policy changes designed to encourage borrowers to work with their servicers and pursue alternatives to foreclosure. Defaulting borrowers who walk-away and had the capacity to pay or did not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure. Borrowers who have extenuating circumstances may be eligible for new loan in a shorter timeframe.

"We're taking these steps to highlight the importance of working with your servicer," said Terence Edwards, executive vice president for credit portfolio management. "Walking away from a mortgage is bad for borrowers and bad for communities and our approach is meant to deter the disturbing trend toward strategic defaulting. On the flip side, borrowers facing hardship who make a good faith effort to resolve their situation with their servicer will preserve the option to be considered for a future Fannie Mae loan in a shorter period of time."

Fannie Mae will also take legal action to recoup the outstanding mortgage debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments. In an announcement next month, the company will be instructing its servicers to monitor delinquent loans facing foreclosure and put forth recommendations for cases that warrant the pursuit of deficiency judgments.

Troubled borrowers who work with their servicers, and provide information to help the servicer assess their situation, can be considered for foreclosure alternatives, such as a loan modification, a short sale, or a deed-in-lieu of foreclosure. A borrower with extenuating circumstances who works out one of these options with their servicer could be eligible for a new mortgage loan in three years and in as little as two years depending on the circumstances. These policy changes were announced in April, in Fannie Mae's Selling Guide Announcement SEL-2010-05.

However, Rortybomb asks:

1) Why don’t they cramdown these mortgages? Why don’t they do a Right-To-Rent process? “Loan modification” has turned out historically to increase the balance of the loan by capitalizing fees and then just spinning out the length of the loan.

We know from HAMP analysis, specifically carried out by Analysis of Mortgage Servicing Performance, that 70% of modified mortgages have a principal increase (data discussed here):

And that a surprising amount of them redefault a year out:

There is no working definition of predatory lending, but a loan that has a negative amort (increases the balance) and a person is unlikely to be able to pay seems like a good working definition of predatory lending. If the GSEs are going to pressure people into modifications, I wonder what their expectations are of how much principal will be reduced and how likely it is people will immediately redefault. We didn’t do this with HAMP, even though we should have, and HAMP is a disaster nobody will stand by.

Reducing principal, especially cramming it down to the market rate, is a plan to save a mortgage and get homeowners back on track. Modifications have a history of kicking a serious problem 10 yards down the road. And don’t be mad Fannie, but the “we’ll just kick the can for now” solution seems right up your alley.

2) Annie Lowrey has a good catch in When Underwater Homeowners Walk Away, with this Federal Reserve paper The Depth of Negative Equity and Mortgage Default Decisions:

After distinguishing between defaults induced by job losses and other income shocks from those induced purely by negative equity, we find that the median borrower does not strategically default until equity falls to -62 percent of their home’s value. This result suggests that borrowers face high default and transaction costs. Our estimates show that about 80 percent of defaults in our sample are the result of income shocks combined with negative equity. However, when equity falls below -50 percent, half of the defaults are driven purely by negative equity. Therefore, our findings lend support to both the “double-trigger” theory of default and the view that mortgage borrowers exercise the implicit put option when it is in their interest.

The median 2006 borrower from the four housing disaster states doesn’t strategically default until LTV is at 162, and even then it is mostly from income shocks (unemployment, health care, etc.). For what it is worth, we ran some numbers here:

And if you are an LTV of 160, it will be, under generic estimates, a range of around 8 to 12 years until you are above water. You “own” (and have to upkeep) a place you are a decade out from owning. So a 7 year penalty has to be taken in context.

That paper has issues that could be extrapolated (we don’t need the median borrower to walk away before we have major problems), but it’s important to us to have a clear sense that there is an actual problem here, as opposed to the income shocks of near 20% underemployment.

3) Fannie is saying homeowners should be working with the servicers here. And they should. But it is worth noting that even when we bribe servicers to “nudge” them, as we have done in HAMP, we still don’t actually get principal cuts. Shahien Nasiripour has just found, “As few as 0.1 percent of mortgage modifications initiated under the Obama administration’s signature foreclosure prevention program involve reductions in principal, according to a federal report released Wednesday…A January report by the State Foreclosure Prevention Working Group noted that principal reduction is the best way to stem the foreclosure crisis.” Usually these involve payment increases, unless they lengthen the period of the loan, which means more time underwater.

HAMP, the Obama adminstration’s foreclosure prevention program, has gone from “look busy” to “not working” to utter, complete disaster. A complete waste of time, resources and energy. And Fannie now wants to replicate it. Let’s see how this goes.

Are foreclosures racist?

2010-06-18T14:15:00.001-04:00

Felix Salmon reports that "if you’re a high-income Latino with a mortgage, you’re almost twice as likely to be facing foreclosure than a high-income non-Hispanic white person. "

And in general, the foreclosure crisis is hitting blacks and Latinos much harder than it is whites, according to a startling new report from the Center for Responsible Lending.

Overall, there have been 790 foreclosures per 10,000 loans to blacks, and 769 for Hispanics — compared to just 452 to non-Hispanic whites. And within every income group, the disparities are startling: here’s the chart.

Lenders go after money lost in foreclosures

2010-06-16T07:47:00.003-04:00

The Washington Post reports that "over the past year, lenders have become much more aggressive in trying to recoup money lost in foreclosures and other distressed sales, creating more grief for people who thought their real estate headaches were far behind."

In many localities -- including Virginia, Maryland and the District -- lenders have the right to pursue borrowers whose homes have sold at a loss to collect the difference between what the property sold for and what the borrower owed on it, also called a deficiency.

Before the housing bust, when the volume of foreclosures was relatively low, lenders seldom bothered to chase after deficiencies because borrowers had few remaining assets to claim and doing so involved hassles and costs. But with foreclosures soaring, lenders are more determined to get their money back, especially if they suspect borrowers are skipping out on loan they could afford, an increasingly common practice in areas where home values have tanked...
Those who had a second mortgage, such as a home-equity line of credit, in addition to their primary mortgage may find themselves particularly vulnerable, especially if they tapped into the equity line for cash.

Second lenders are last in line to get paid when a distressed property is sold. There's usually little or no money left over for them, making it more likely that they will pursue large deficiencies, several attorneys said...
A handful of states do not allow lenders to pursue deficiencies, nor does a federal program that took effect April 10. Lenders participating in that initiative are paid for approving short sales and as a condition, they cannot go after outstanding debt.

In many states, lenders can go after deficiencies, though laws vary widely, said John Rao, an attorney at the National Consumer Law Center. Some states limit how long the banks have to file a claim or collect the debt. Others may calculate deficiencies based on the fair-market value of the house, Rao said. For instance, if a home sells for $200,000 yet its fair market value is $250,000, "the borrower who owes $240,000 on the mortgage would not have a deficiency," he said.
Borrowers should get a waiver in writing from their lenders to protect themselves, said Diane Cipollone, an attorney at the nonprofit Civil Justice. "Nobody should assume the deficiency is forgiven," she said.

Ax may fall on tax break for mortgages

2010-06-09T09:31:00.000-04:00

The Hill reports that "the popular tax break for mortgage interest, once considered untouchable, is falling under the scrutiny of policymakers and economic experts seeking ways to close huge deficits."

Although Congress last year rejected the White House’s proposed cut to the amount wealthier taxpayers can deduct for home mortgage interest payments, the administration included it again in its 2010 budget — saying it could save $208 billion over the next decade.
And now that sentiment has turned against all the federal red ink — and cost-cutting is in vogue — Democrats on President Barack Obama’s financial commission are considering the wisdom of permanent tax breaks such as the mortgage deduction and corporate deferral. Calling them “tax entitlements,” senior Democratic lawmakers have argued they should be on the table for reform just like traditional entitlement programs Medicare, Social Security and Medicaid.
The new spotlight on the mortgage deduction and other tax expenditures comes as the Obama administration and Congress consider ways to reduce deficits the Congressional Budget Office (CBO) expects will average nearly $1 trillion over the next decade.
Policymakers seeking savings have tried to cap the mortgage interest deduction before — and failed. Five years ago, a bipartisan tax reform commission created by President George W. Bush proposed ending the mortgage tax break. But the commission’s plan stalled in Congress, partly because of popular support for the mortgage deduction.
Obama’s proposal, which would cut the deduction rate for itemized expenses for those making more than $250,000 to the rate paid by the middle class, was panned last year by members of both parties. They worried about its effect, during a recession, on charitable deductions and the housing market.
The White House says it was included in the president’s budget proposal again this year because it remains a good idea.
“The proposal will correct inequities in our tax code that allow millionaires to benefit from higher itemized tax deductions than middle-class families enjoy,” said Meg Reilly, spokeswoman for the Office of Management and Budget (OMB).
Although the backers of the mortgage interest tax break defend it as a key incentive for people to own rather than rent their homes, some say that’s not so. A Brookings-Urban Tax Policy Center study found that the mortgage interest tax break costs more than $100 billion annually but does little to encourage the middle class and less wealthy to buy homes.
“I’m not sure that we need to subsidize homeownership at all through the tax system,” said Eric Toder, the study’s lead author.
A bipartisan tax reform proposal this year by Sens. Judd Gregg (R-N.H.) and Ron Wyden (D-Ore.) would lower base tax rates and eliminate a host of tax expenditures, but not the mortgage deduction. Gregg and Wyden said they left it out because they wanted a “politically viable vehicle,” conceding that ending the mortgage break would mean less support for their plan from other lawmakers.

More Consumers Making Payments on Their Credit Cards Before Their Mortgages

2010-06-08T17:40:00.001-04:00

Posted on the TransUnion website:

A new study developed by TransUnion confirms that the "new" payment hierarchy -- where consumers pay their credit cards prior to their mortgages -- is continuing, with the trend occurring more readily than ever before.
"Conventional wisdom has always been that, when faced with a financial crisis, consumers will pay their secured obligations first, specifically their mortgages," said Sean Reardon, the author of the study and a consultant in TransUnion's analytics and decisioning services business unit. "However, a recent TransUnion analysis has found that increasingly more consumers are paying their credit cards before making mortgage payments. This analysis reaffirms the results of a previous TransUnion study that examined data between the third quarter of 2006 and the first quarter of 2008."
The percentage of consumers current on credit cards and delinquent on mortgages first surpassed the percentage of consumers current on their mortgages and delinquent on credit cards in the first quarter of 2008. This "flip" is representative of the change in the conventional wisdom around the payment hierarchy, or which debt obligations consumers would choose to pay first.
The latest study, conducted on consumers that had at least one credit card and one mortgage, examined 30-day credit card and mortgage delinquency data between the second quarter of 2008 (Q2/2008) and the third quarter of 2009 (Q3/2009). Although many industry analysts believed that a reversion to the conventional payment hierarchy would ensue once we had passed through the worst of the recession -- that has not, in fact, been the case. To the contrary, this study found that the hierarchy reversal has become even more widespread, with the percentage of consumers who are delinquent on their mortgages and current on their credit cards rising to 6.6 percent in Q3/2009 (from 4.3 percent in Q1/2008). Conversely, the percentage of consumers who are delinquent on their credit cards and current on their mortgages has decreased to 3.6 percent in Q3/2009 (from 4.1 percent in Q1/2008).
"This same trend is evident within the lowest scoring risk segment," added Reardon. "Moreover, it should be noted that the 'flip' in payment hierarchy in the lowest scoring segment was evident earlier during Q4/2007, compared to Q1/2008 for the total market."
The study found that the magnitude of delinquency in the lowest scoring segment is significantly higher than that of the total market. The delinquency rate for consumers in this segment who were delinquent on their mortgages but current on their credit cards during Q4/2007 was 19.1 percent, and rose to 29 percent in Q3/2009. In a trend similar to that of the total market, the percentage of consumers delinquent on their credit cards but current on their mortgages decreased from 18.1 percent in Q1/2008 to 14.5 percent in Q3/2009.
The payment hierarchy shifts are even more pronounced in states such as California and Florida that experienced a more severe housing bubble effect. Within California, the percentage of consumers delinquent on their mortgages but current on their credit cards increased from 3.5 percent in Q3/2007 to 10.2 percent in Q3/2009 (a 191 percent increase). In Florida, this same variable increased from 5.1 percent in Q3/2007 to 12.4 percent in Q3/2009 (a 143 percent increase). In this same timeframe, the United States experienced a 68 percent increase (from 4.0 percent in Q3/2007 to 6.6 percent in Q3/2009).
In contrast, the number of California consumers delinquent on their credit cards but current on their mortgages declined from 3.3 percent in Q3/2007 to 2.7 percent in Q3/2009. In Florida, this variable declined from 5.0 percent in Q3/2007 to 3.9 percent in Q3/2009.
"The implosion of the mortgage industry over the last 24 months, the resetting of adjustable-rate mortgages and the weak job market have all come together to redefine how consumers are managing their finances and meeting (or not meeting) their credit obligations," said Ezra Becker, director of consulting and strategy in TransUnion's financial services business unit. "The insight gained through this analysis reveals a lot about changing consumer preferences. The financial services industry must recognize and adjust to the payment hierarchy shift with judicious modifications to business models, new assessments of specific areas of risk, and by strategic revisions to acquisition and account management strategies."
The source of the underlying data used for this analysis was TransUnion's Trend Data, a proprietary historical database consisting of 27 million anonymous consumer records randomly sampled every quarter from TransUnion's national consumer credit database. Using TransUnion's standard definitions of credit card and mortgage trades, TransUnion was able to create and evaluate the custom attributes that are the basis of this study.

And from FICO:

FICO (NYSE:FICO), the leading provider of analytics and decision management technology, today announced new and troubling findings uncovered in the latest analysis offered by its subscription service for businesses, FICO® Score Trends. Reversing a long historic trend, mortgage default risk for consumers with high FICO® scores now exceeds their credit card default risk, even though most credit cards are unsecured credit and mortgages are secured by real estate. The company observed a parallel rise in mortgage delinquencies for higher-scoring U.S. consumers.
According to the analysis in FICO Score Trends, recent repayment behavior across the financial services industry has shifted significantly from historical trends. In 2008-2009, bankcard accounts were just 1.6 times more likely to become 90 days delinquent than were mortgage loans. By comparison, in 2005 bankcard accounts were more than three times more likely to become 90 days delinquent. And for borrowers scoring high on the FICO® score’s 300-850 score range, the level of repayment risk actually has become greater for real estate loans than for bankcards. In 2009, 0.3 percent of consumers with FICO scores between 760-789 defaulted on real estate loans, compared to 0.1 percent who defaulted on bankcards.

“We’re identifying lending industry situations in FICO Score Trends that to our knowledge have never been seen before,” said Dr. Mark Greene, CEO of FICO. “Economic instability is creating unknown risk in lenders’ credit portfolios as well as counter-intuitive trends in consumer behavior. While the FICO 8 score continues to prove its unprecedented power in rank-ordering consumers for risk, even low-risk consumers are changing the value they give different credit lines. As the CARD Act goes into effect next week, it likely will create additional, unhelpful pressures on the banking business.”

In FICO Score Trends, company experts found new evidence that lenders tightened their criteria for new loans in 2008-2009 and began “cherry picking” the kinds of borrowers to whom they would extend credit. Mortgage loans opened last year between April and October reflected significantly tighter standards than in prior years. In 2005, nearly 46 percent of consumers who opened a new mortgage had a FICO score less than 700. In 2008 this percentage had dropped to just 25 percent of the newly booked mortgage population. Other industry sectors experienced similar shifts. In the bankcard sector in 2005, 51 percent of consumers with a new credit card had FICO scores less than 700. That percentage dropped to just 38 percent in 2008. As lenders tightened their credit standards, it became correspondingly more difficult for consumers with delinquencies in their credit histories and lower FICO scores to qualify for additional credit.

Regional shifts in risk
FICO also examined FICO Score Trends to learn how credit risk of real estate loans and bankcards varied across U.S. regions. The company found the most dramatic shift in the Pacific region. In 2005, bankcards were 6.4 times more likely to default than were mortgage loans. That percentage dropped to only 1.3 times riskier in 2009.

Consumers in the Midwest region demonstrated the smallest relative change. Bankcards were 2.5 times more risky of default than were mortgages in 2005, but bankcards were just 1.5 times more risky of default by 2009. Borrowers in the Northeast continue to present the least amount of default risk nationally for real estate loans.

These observations were taken from FICO® Score Trends, the subscription service that provides lenders with unique access to industry FICO® score trends indexed by a range of criteria such as industry, geography and time period. Lenders regularly use FICO Score Trends to benchmark their own portfolios and trends in order to improve their risk management and forecasting.

Subprime Mortgage Default

2010-06-03T07:43:00.001-04:00

By James B. Kau, Donald C. Keenan, Constantine Lyubimov and V. Carlos Slawson Jr.

Abstract: Using data on privately-securitized subprime ARMs (adjustable rate mortgages) originated between 1997 and 2008 and observed between 2000 and 2008, and so covering the start of the subprime crisis, this paper constructs a reduced-form credit risk model of default, and then uses contractual properties of the loans to infer the market’s price of default risk at various times of origination.

Treating the hazard of default as a process rather than a single realization for each period of origination permits the probability of default to be calculated without knowledge of the still unfolding hazard realization, allowing one to adopt the same position as lenders, who also cannot foretell the future. It is empirically determined that a change in the inherent nature of borrowers caused some deterioration in their default behavior, a change which we can first detect by late 2004, but of which, evidence indicates, the secondary mortgage market became aware at about the same time. The large rise in defaults in 2007 cannot, therefore, be attributed to any surprise other than the unexpectedly large fall in housing prices.

Download here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1596202

BofA Begins Principal Reduction on Delinquent, Underwater Mortgages

2010-06-02T16:38:00.002-04:00

CNBC's Diana Olick:

This morning executives at Bank of America rolled out their new "Principal Reduction Enhancement" program, which is an earned principal forgiveness plan for borrowers behind on their mortgages and whose loans are at least 20 percent underwater in value.

The plan is in conjunction with the government's Home Affordable Modification Program, but the government's principal reduction plan isn't in place yet.

What makes BofA's plan so proactive is that it employs, "a principal reduction as the first step toward reaching HAMP’s affordable payment target of 31 percent of household income when modifying certain NHRP-eligible mortgages — ahead of lowering the interest rate and extending the term."

On the conference call to announce the program this morning, BofA's credit loss mitigation executive, Jack Schakett, said the amount of strategic defaulters (those who can pay their loans but opt not to) are "more than we have ever experienced before." He went on to say, "there is a huge incentive for customers to walk away because getting free rent and waiting out foreclosure can be very appealing to customers."

Schakett says the foreclosure process is still taking 13 to 14 months (and by my estimates that's an optimistic assessment), and so there's over a year of free rent. While the banks are trying to improve the time, they're just not there yet.

31 percent of foreclosures in March were deemed to be "strategic default" by researchers at University of Chicago and Northwestern University.

That's up from 22 percent in March of 2009.

We already know that mortgage walkaways are more prevalent among borrowers whose neighbors or friends have done the same thing.

We also learn from those same researchers that the likelihood of walking away increases by 23 percent when homeowners learn that a neighbor got some principal forgiveness...

And some details on the program from the Housing Wire:

The bank will attempt a principal reduction as the first step in the servicer waterfall to reach the 31% debt-to-income ratio target – the amount of the borrower monthly income that goes toward the mortgage. Loans eligible for the NHRP include subprime, pay-option adjustable rate mortgages (ARM) and prime-quality two-year hybrid ARMs originated by Countrywide before Jan. 1, 2009. The amount of principal owed must exceed the property value by 20%, and the loan must be delinquent by 60 or more days.

Through the five-year NHRP, BofA sets up an interest-free forbearance account for the amount of principal owed above the current value of the home. For instance, if the borrower owes $250,000 on a home worth $200,000 and qualifies for the program, BofA will set up a separate account of $50,000 that will sit alone without collecting interest while the borrower makes payments on the $200,000 at the current market interest rate. There are no required payments on the $50,000 non-interest bearing mortgage account.

For the first three years of the NHRP, BofA reduces the separate account – the $50,000 in the example above – by 20% each year if the borrower remains current. Meaning after three years, $30,000 would be forgiven in the example. If, by then, house prices have gone up and the borrower is once again at a 100% loan-to-value ratio, BofA will no longer reduce the principal. If the borrower remains above 100% LTV, BofA will continue reducing payments for an additional two years.

BofA will not reduce the principal on the non-interest bearing mortgage account if the sum of both mortgages achieves 100% LTV....
Schakett added that of the BofA borrowers currently moving through the HAMP process, 45% had an LTV of more than 120%.

“Our tests have shown that many homeowners who are severely underwater on their mortgages will respond positively to a modification offer that includes reduction of their principal balance, increasing the rates of acceptance of HAMP trial modification offers, conversion to permanent modifications and long-term success of the homeowner,” Schakett said.

Should We Dump the Home Mortgage Interest Deduction?

2010-05-28T15:26:00.001-04:00

Originally posted on TaxVox:

Do we want to use the tax code to subsidize home ownership? And, if we do, is the mortgage interest deduction the best way to do it? A new paper by my Tax Policy Center colleagues Eric Toder and Katherine Lim, along with Urban Institute researchers Margery Turner and Liza Getsinger, asks these provocative questions, and comes up with some surprising answers.

To even ask seems almost un-American—almost like suggesting we replace barbeque at the Memorial Day picnic with, oh, tofu. But a close look suggests there is much less to the hallowed deduction than meets the eye. Thus, we’d miss it much less than we think.

In 2012, the deduction will reduce federal revenues by $131 billion. In contrast, the entire budget for the Department of Housing and Urban Development is just $48 billion. The conventional wisdom says these tax breaks are important because A) they increase home ownership and B) homeowners are more engaged in their communities than renters.

It turns out that neither of these assumptions is necessarily true. For instance, for a half century--until the recent real estate boom and bust--home ownership rates in the U.S. have barely budged even though the value of the deduction has fluctuated widely. Similarly, there is no clear connection between home ownership and the availability of mortgage deductions in other countries.

The exact relationship between home ownership and other social benefits is just as uncertain. We know home owners are more connected to their communities than renters. But is that because they own a house, or is it merely that the same types of people who are engaged in their communities are also prone to home ownership? We don’t really know.

We do know, however, that the deduction is not a very efficient way to encourage home ownership. Most benefits go to high-income households that would probably buy a house with or without the deduction. Since non-itemizers get no benefit from the deduction, it is not surprising that most of the subsidy goes to upper-bracket taxpayers.

So is there a better way? The paper looks at a half-dozen alternatives, from eliminating the mortgage subsidy entirely to capping its value or turning it into a credit. Not surprisingly, each design has its own set of winners and losers.

To take one example: If the goal is to encourage homeownership among people who otherwise would not buy, what if we replaced the deduction with a credit? Remember that credits are usually a better deal for middle-income households. Simple example: A 20 percent credit on $1,000 of interest is worth $200 no matter what your tax bracket or whether you itemize. But a $1,000 deduction is worth $350 to someone in the 35 percent bracket but only $100 to an itemizer in the 10 percent bracket, and nothing to someone who takes the standard deduction ).

The paper looks at four different credits, each of which provides the same total subsidy amount as the current deduction. For instance, replacing the deduction with a non-refundable credit equal to 20 percent of interest payments would raise average after-tax incomes for households in the lowest 80 percent of the income distribution, with middle-income households getting the biggest average benefit. However, on average those in the top 20 percent would do less well with the credit than with today’s deduction. A non-refundable 100% credit capped at about $2,000 would benefit middle-income households even more but raise taxes more for people in the top 20 percent.

Sadly, the study also explains why the deduction is likely to stay right where it is. The big winners under the current system are upper-middle-class suburbanites who disproportionately own homes, itemize deductions, and spend a relatively large share of their income on mortgage interest. And nobody wants to get them mad, either by cutting their housing subsidies or feeding them tofu.

Finra probing mortgage-debt offerings

2010-05-28T15:24:00.001-04:00

Originally posted on the Reuters website:

Wall Street regulator FINRA is investigating the accuracy of disclosures surrounding subprime mortgage-backed security offerings, FINRA enforcement director James Shorris told a gathering of securities industry executives on Thursday.
The Financial Industry Regulatory Authority is taking a hard look at whether broker-dealers made "misstatements" or included "erroneous" information about their offerings, among other issues and practices.
Shorris, speaking on a panel during FINRA's annual conference, did not elaborate during the session. FINRA declined further comment on the investigation.
MBS are pools of loans that are packaged into fairly conventional securities. As housing prices soared in 2006 and 2007, lenders underwrote increasingly risky loans.
The 2007 crash in housing prices and collapse of mortgage markets fueled hundreds of billions of dollars in losses for investors and banks worldwide holding MBS and collateralized debt obligations (CDOs) that were suddenly more risky than advertised and difficult to trade.
"Subprime" mortgages, which refer to loans made to people with poor credit, were only one of a long list of issues now under scrutiny by FINRA, Shorris told a standing-room-only audience.
FINRA continues to look for fraud in swaps transactions executed for municipalities and Regulation D private placements, a little-watched corner of the market. It is also examining auction-rate debt securities, billions of dollars of which remain frozen after more than two years.
He also stressed his concern about a number of complex investments that are, in short, poorly explained, little understood by brokers and sold to the wrong people. This category includes reverse convertibles, equity-indexed annuities and leveraged or inverted ETFs.
Shorris also called attention to a trend where unregistered and unregulated foreign firms lend cash for stock held by U.S investors, with the expectation of returning the shares in two years.
Instead these firms liquidate the stocks, leaving investors stuck with a big tax bill and a transaction that cannot be unwound.

Take This House and Shove It: The Emotional Drivers of Strategic Default

2010-05-17T16:37:00.000-04:00

By Brent T. White:

Abstract: An increasingly influential view is that strategic defaulters make a rational choice to default because they have substantial negative equity. This article, which is based upon the personal accounts of over 350 individuals, argues that this depiction of strategic defaulters as rational actors is woefully incomplete. Negative equity alone does not drive many strategic defaulters’ decisions to intentionally stop paying their mortgages. Rather, their decisions to default are driven primarily by emotion – typically anxiety and hopelessness about their financial futures and anger at their lenders’ and the government’s unwillingness to help. If the government and the mortgage industry wish to stem the tide of strategic default, they must address these emotions.

Because emotions are primary, however, principal reductions may not be necessary. Rather, many underwater homeowners simply need some reason to feel less apprehensive about the financial consequences of continuing to pay their underwater mortgages. One possible way to provide this comfort would be a “rent-based loan program,” allowing underwater homeowners to refinance their entire balances to an interest rate that would bring their mortgage payment in line with the rental cost of a comparable home. Indeed, a rent-based approach would relieve many underwater homeowners’ financial anxiety and likely be enough alone to stem the tide of strategic default.

Download paper here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1603605

Experian Provides New Level of Transparency for Non-Agency MBSs

2010-05-10T12:20:00.001-04:00

NEW YORK, May 10 /PRNewswire/ -- Experian®, the global information services company, today announced the launch of CreditHorizons(SM) for Securities, a data-feed product that provides the missing link to understanding the true creditworthiness of the underlying borrowers in each mortgage deal. CreditHorizons for Securities consists of anonymized U.S. consumer credit profiles that have been matched to the private-label securitized mortgage deals in the industry-leading loan-level database from First American CoreLogic/Loan Performance.

Investors who currently utilize only traditional loan-level data will find that CreditHorizons for Securities affords them a new set of influencers in delinquency and loss forecasting, helping to optimize pricing strategies, improve risk management and hedging strategies and increase confidence in residential mortgage–backed securities buy and sell decisions.

"Monthly trustee and servicer data sets provide a limited foundation for predicting payment patterns," said Ethan Klemperer, general manager of Experian Capital Markets. "To compete profitably in today's market, investors need upgraded valuation methods with increased transparency and predictive power. We're delighted to work with First American CoreLogic to launch CreditHorizons for Securities, providing the critical behavioral data needed to determine the true value and future payment trend of clients' securities."

"We're pleased to join Experian in bringing CreditHorizons for Securities to the marketplace," said George Livermore, president, data and analytics segment for The First American Corporation. "By augmenting existing modeling with consumer credit information, investors obtain a holistic view of the underlying collateral and can better predict delinquency and default probabilities for their residential mortgage–backed securities portfolios."

Experian's CreditHorizons for Securities offers a predefined set of more than 50 anonymized consumer credit data variables that have been carefully evaluated and selected for their predictive ability by Experian's team of credit experts. Maintaining a relatively small number of variables ensures that the product is user-friendly and easy to implement.

T2 Partners Latest Mega-Case Against Housing And The Homebuilders

2010-05-10T11:55:00.004-04:00

Business Insider reports that "Whitney Tilson has now updated his housing presentation to continue to make the case that that with the Dow Jones Homebuidlers Index (ITB) up 133%, there's big money to be made betting against it."

See the presentation here: www.businessinsider.com/t2-partners-housing-market-2010-5/-1

Willingness to Walk Away: Strategic Default on the Rise

2010-05-01T09:13:00.003-04:00

Building on previous research, Paola Sapienza and Luigi Zingales:

...found that the number of homeowners willing to default when the value of a mortgage exceeds the value of their house, even if they can afford to pay their mortgage, dramatically increased compared to just a year ago. The percentage of foreclosures that were perceived to be strategic was 31 percent in March 2010, compared to 22 percent in March 2009.
One likely reason for this growing trend is the increasing perception that lenders are not going after borrowers who walk away. In December 2009, the average homeowners surveyed said the probability that a lender will go after a borrower is 56 percent, as compared to 54 percent reported in March 2010.

“With more and more homeowners believing that lenders are failing to pursue those who default on their mortgages, there is a risk that a growing number of homeowners will walk away from their homes even if they can afford monthly payments.” said Sapienza.

The growing importance of strategic defaults is in line with the recent Obama administration’s new set of housing initiatives.

The results also indicate that the likelihood of strategic default increases by 23 percent when homeowners learn that their neighbor with negative equity has received a partial loan for forgiveness. Additionally, strategic default increases by 29 percent if homeowners are able to find an alternate way to finance a new home.

“A key deterrent to strategic default is the fear of losing a good credit score,” said Zingales. “Approximately 74 percent of homeowners in our survey believe it is very important to maintain good credit and this can be a factor in encouraging them not to walk away.”

These findings build upon a paper the researchers released in June 2009 entitled “Moral and Social Restraints to Strategic Default on Mortgages,” which looked at American homeowners’ propensity to strategically default. The paper was the first to analyze and quantify the extent of strategic default during the current recession.

Geithner vows crackdown on mortgage servicers

2010-04-29T16:50:00.002-04:00

Original posted in the Washington Post:

Treasury Secretary Timothy Geithner on Thursday slammed mortgage service companies for failing to do enough to help Americans avoid losing their homes and promised to crack down on shoddy practices.
"We do not believe servicers are doing enough to help homeowners -- not doing enough to help them navigate the difficult and frightening process of avoiding foreclosure," Geithner said in prepared remarks for delivery to a Senate appropriations subcommittee.

He said Treasury was "troubled" by reports that servicers had done things like foreclose on homeowners who were potentially eligible for relief under the government's Home Affordable Mortgage Program, lost documents or claimed to have done so and even steered troubled homeowners away from available assistance.

"None of this is acceptable," Geithner said, adding that Treasury was doing "targeted, in-depth compliance reviews" to make sure that servicers were acting in good faith.

"In circumstances where servicers are not compliant we will withhold incentives or demand their repayment," he said, referring to fees that servicers earn through the HAMP program by helping homeowners adjust their loan payments so that they can avoid foreclosure.
Geithner said Treasury soon will publish "much more detailed data on the performance of servicers" so that lawmakers and ordinary citizens can gauge for themselves whether the service companies are acting in good faith.

House Democrats Introduce Right-to-Rent Bill for Borrowers Facing Foreclosure

2010-04-29T16:47:00.001-04:00

Original posted on the Housing Wire by Austin Kilgore:

Borrowers who have exhausted all options for saving their homes may be thrown yet another retention lifeline, if House Democrats are successful with recently introduced legislation.

A bill filed in the US House of Representatives would allow mortgage borrowers to remain in their homes, as renters, for up to five years after receiving a foreclosure notice.

The “right to rent” bill, House Resolution (HR) 5028, would allow borrowers to petition a judge to stay in their homes as renters under a lease for up to five years. The judge would be empowered to appoint an independent appraiser to set fair market value, which would be allowed to rise with inflation, Representatives Raúl Grijalva (D-OH) and Marcy Kaptur (D-OH) said in a joint release. The bill is an updated version of a similar bill Grijalva introduced in 2008.

Grijalva said reports of increased foreclosure activity are “an indication of the profound, historic crisis we face and the need for creative solutions like Right to Rent. I’m proud to work with a champion of workers’ rights like Marcy Kaptur to address this problem, and I call on the rest of Congress to take a hard look at why we’ve allowed things to get this bad.”

While the Making Home Affordable Modification Program (HAMP) continues to make some effort in attempts to prevent foreclosures, Grijalva said it is not enough.

“HAMP is simply an insufficient response to this crisis,” Grijalva said. “Right to rent is a fair and sensible solution for struggling homeowners. Banks will still get reliable rental income, and families will be able to stay in their homes and significantly lower their monthly housing costs.”

The right to rent program would be limited to homes purchased at or below the median price for its metropolitan statistical area, and must have been the borrower’s principal residence for no less than 2 years. Only mortgages originated before July 1, 2007 will be eligible.

“Passing this bill will help neighborhoods avoid the spiral of decay, crime and lower property values that often follows mass vacancies without creating any new bureaucracy or transferring a dime of taxpayer money to homeowners or banks,” Grijalva said.

‘Strategic’ Mortgage Defaults Jump to 12% of Total

2010-04-29T16:43:00.002-04:00

Originally posted on Bloomberg by Jody Shenn:

Decisions by U.S. homeowners to walk away from mortgages they can afford account for an increasing share of defaults, according to Morgan Stanley.
About 12 percent of all mortgage defaults in February were “strategic,” up from 4 percent in mid-2007, New York-based Morgan Stanley analysts led by Vishwanath Tirupattur wrote in a report today. Borrowers are more likely to stop paying their mortgages the higher their credit scores and the larger their loans, the analysts said.

Defaults by borrowers who owe more than their homes’ values are among the biggest risks for the housing market, according to analysts including Zelman & Associates’ Ivy Zelman and Amherst Securities Group LP’s Laurie Goodman. Last month, the Obama administration said it would adjust its anti-foreclosure program to encourage reductions to borrowers’ principal amounts, instead of just the payments they make, to address the issue.

That change “gives us hope that policy makers are serious about curbing future strategic defaults,” the Morgan Stanley mortgage-bond analysts wrote.

Strategic defaults also increase based on how much more borrowers owe in housing debt than their homes are worth, they said in the report, which made use of consumer credit data from Transunion LLC and Standard & Poor’s home-price indexes.

That finding concurred with reports by Goodman, a New York- based mortgage-bond analyst, who has said there will be as many as 12 million foreclosures over the next few years unless lenders can effectively modify borrowers’ debt.

Falling Prices

A fifth of U.S. homes carrying mortgages were worth less than their loans in the fourth quarter, according to Seattle- based Zillow.com, which runs a real estate data Web site. Home prices in 20 metropolitan areas tumbled 33 percent from July 2006 through April 2009, then rose for five months before falling for the next five, leaving them up 2.8 percent from lows, according to an S&P/Case-Shiller index.

Morgan Stanley said many previous studies of strategic defaults have been limited by a lack of a “precise definition” of when they are occurring.

The analysts classified a default as strategic only when homeowners who hadn’t been previously delinquent were making on- time payments one month, then skipped them for the next three, even while staying current on other consumer debt of at least $10,000.

Prime-Jumbo Problem

For mortgage-bond investors, the data signals a problem with prime-jumbo debt and strengthens the case for investing in subprime, the analysts wrote. That’s in part because strategic defaults are less prevalent among borrowers with subprime characteristics and they may benefit from government-aid programs that don’t target large loans, the analysts wrote.

Jumbo mortgages are larger than government-supported Fannie Mae and Freddie Mac can finance, currently from $417,000 to $729,750 in high-cost areas.

Details needed to implement the planned changes to the federal “Home Affordable” mortgage-modification program for delinquent borrowers are expected by “early fall,” Phyllis Caldwell, the Treasury Department’s chief homeownership preservation officer, told lawmakers April 14. The program will then push for cuts in the principal amounts of some borrowers that owe more than 115 percent of their home’s value.

A total of 9.47 percent of all home mortgages were delinquent at the start of this year, with an additional 4.58 percent in the foreclosure process, according to seasonally adjusted Mortgage Bankers Association data.

‘Big Overhang’

Housing won’t recover for three to five years as mounting foreclosures hold down prices, mortgage-bond pioneer Lewis Ranieri said yesterday in a panel discussion at the Milken Institute Global Conference in Beverly Hills, California.

“There’s another big leg down,” he said. “You can’t have much of a rally when you’ve got this big overhang.”

In an April 13 congressional hearing, JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp., and Wells Fargo & Co., the biggest U.S. home lenders, said their foreclosure- prevention efforts are working and rejected plans that could force them to reduce balances for distressed homeowners.

“Broad-based principal reduction could result in decreased access to credit and higher costs to consumers because lenders will price for forgiveness risk,” said David Lowman, head of New York-based JPMorgan’s mortgage unit.

Bank of America last month agreed to cut the principal on some loans that exceed 120 percent of the value of underlying properties as part of a settlement with 44 state attorneys general over lending by Countrywide Financial Corp., which the Charlotte, North Carolina-based bank bought in 2008.

Commercial Defaults

Strategic defaults are also increasing in the commercial real-estate market, where prices are down 42 percent from their peak in October 2007, according to Moody’s Investors Service.

Morgan Stanley last year defaulted on a $2 billion loan two years after it bought Crescent Real Estate Equities Co. and handed over 17 million square feet of office buildings to lender Barclays Capital. The bank also agreed to relinquish five San Francisco office buildings to its lender, two years after buying them from Blackstone Group LP.

In January, Tishman Speyer Properties LP and BlackRock Inc. defaulted on a $3 billion mortgage on Manhattan’s Stuyvesant Town and Peter Cooper Village apartments, the largest residential enclave in New York City. Its sale in 2006 for $5.4 billion marked the biggest single real estate transaction in history U.S. history.

Moody’s Assigns Redwood RMBS Triple-A as S&P Warns on Credit Risk

2010-04-29T14:24:00.003-04:00

Original posted on the Housing Wire by Diana Golobay:

Redwood Trust closed a $237.8m prime jumbo residential mortgage-backed security (RMBS) sponsored by its wholly-owned subsidiary, RWT Holdings. The deal marks the first private-label RMBS in the US since 2008, and is already bringing about disagreements from the credit rating agencies on the strength of predicted performance.

CitiMortgage originated the 255 underlying first-lien mortgages in 2009, Redwood said. The first prime jumbo RMBS in years has been praised by the industry for beginning to thaw the jumbo market.

“This transaction has broken the ice in the private mortgage securitization market, which has been essentially frozen since 2008,” said Brett Nicholas, chief investment officer of Redwood Trust, in a press statement Wednesday.

Moody’s Investors Service rated the most senior securities in the deal — representing 93.5% of the principal amount — triple-A, Redwood said. But fellow credit-rating agency Standard & Poor’s is warning investors of the possible risks associated with the pool characteristics.

Moody’s assigned ratings from triple-A to double-B 2 on five certificates issued by the Redwood RMBS, formally Sequoia Mortgage Trust 2010-H1. Moody’s expects cumulative net loss of 0.5% on the pool, the credit-rating agency said. The 6.5% subordination on the triple-A certificates is driven by both collateral and structural analysis.

“The transaction is backed by high quality prime loans, employs a highly simplified structure compared to past transactions, has a strong governance mechanism with respect to representation and warranties, has good alignment of interests and benefited from a third party review of every loan in this collateral pool,” Moody’s said in an e-mailed statement.

Standard & Poor’s (S&P) on the other hand said that, while the loans have never been delinquent and the borrowers have a weighted average credit score of 768, the average balance of $932,699 poses a “concentration risk.”

In RMBS ratings criteria released in September 2009, S&P established a 7.5% credit enhancement “as an anchor point” for a typical pool of prime mortgages it will rate triple-A. But the Redwood RMBS bears only 6.5% credit enhancement.

“If 33 average-sized loans or the 19 largest loans in the pool were to default at a 50% recovery (the weighted average original LTV ratio is 56.57%), we estimate that either scenario would result in the complete write-down of all the subordinate classes, which provide 6.50% credit enhancement to the senior class,” S&P said in e-mailed commentary Wednesday.

The pool consists of entirely five-year adjustable-rate mortgages, S&P noted, which means the loans will experience reset risk after five years, when the initial fixed rates become adjustable. Nearly 74% of the loans contain a 10-year interest only period, indicating 74% of the borrowers will experience additional reset when the loans become fully amortizing.

“If mortgage rates rise, property values remain flat, and the extension of credit is limited, we believe borrowers may face difficulties refinancing,” S&P said.

Here's the S&P press release:

NEW YORK (Standard & Poor's) April 28, 2010--As part of its efforts to provide
insight to investors on structured finance transactions, Standard & Poor's
Ratings Services has chosen to comment on Sequoia Mortgage Trust 2010-H1
(Sequoia 2010-H1), a U.S. prime jumbo residential mortgage-backed securities
(RMBS) transaction slated to close today. We chose to comment on this
transaction--which appears to be one of the first private-label U.S. RMBS
transaction containing newly originated loans offered this year--because we
believe the transaction is important to the marketplace and that our views can
add value for investors. Standard & Poor's may, from time to time, choose to
provide our views on structured finance transactions across various asset
types and geographies, even if we did not rate the transaction, if we deem the
transaction important to the market and we believe that our opinions would
provide value to investors.

We have reviewed the public information available on the recently announced
Sequoia 2010-H1 transaction, including the preliminary offering document filed
with the Securities and Exchange Commission (SEC), and have assessed various
credit strengths and risk considerations for the transaction (see below),
which we considered relative to our criteria.

The shifting interest structure of this transaction, which uses subordination
for credit enhancement, contains a seven-year lockout period for principal
prepayments, subject to a "two-times" test (which we describe in more detail
below) and delinquency and realized loss performance tests.

STRENGTHS

100% of the borrowers have never been delinquent on their mortgage loans;
The weighted average original credit score of the borrowers is 768;
The weighted average original loan-to-value (LTV) ratio is approximately
56%, and of the 27% of borrowers that have a simultaneous second-lien
mortgage, the weighted average combined LTV ratio is under 60%;
Over 96% of the properties are owner occupied, and over 76% of the
mortgage loans are rate/term refinances;

The offering document indicates that the transaction documents will include
the following provisions:

The definition of 60-plus-day delinquencies includes modified loans for
the first 12 months following the modification;
The definition of realized losses includes principal forgiveness and
principal forbearance; and 
The transaction places an annual cap on administrative and trustee
expenses.

RISK CONSIDERATIONS

Concentration Risk:

The pool consists of 255 residential mortgage loans with relatively high
balances (the average stated balance at cutoff is $932,699.35); as such,
the default of one loan may have a greater impact on overall credit
enhancement than for a pool that contained a greater number of loans or
loans with lower current balances. 
If 33 average-sized loans or the 19 largest loans in the pool were to
default at a 50% recovery (the weighted average original LTV ratio is
56.57%), we estimate that either scenario would result in the complete
write-down of all the subordinate classes, which provide 6.50% credit
enhancement to the senior class.

Reset Risk:

The pool consists entirely of five-year adjustable-rate mortgage loans, and
nearly 74% of these loans contain 10-year interest-only periods. All borrowers
will experience reset risk after five years, when their initial fixed rates
become adjustable, and 74% of borrowers will experience an additional reset
when their loans become fully amortizing. If mortgage rates rise, property
values remain flat, and the extension of credit is limited, we believe
borrowers may face difficulties refinancing.


Geographic Concentration Risk:

More than 46% of the properties in the collateral pool are in California, and
over 16% are in New York State (more than 12% are in New York City).


The "Two-Times" Test:

The offering document provides that in the event that the percentage of
subordinate classes equals twice its original value, subordinate classes may
begin to receive principal prepayments as early as May 2013, if the
transaction passes certain performance tests. If substantial defaults and
losses occur after the time that subordinate classes begin to receive
principal prepayments, then there may be less credit enhancement available to
the senior classes.

Pre-Offering Review Of Property Valuations:

There may have been differences in property valuations of the collateral
arising from variations in the methods that the sponsors, underwriters, and
third-party agents used, which may affect any potential losses for these
properties.


COMPARISON TO STANDARD & POOR'S ARCHETYPICAL POOL

The Sequoia 2010-H1 collateral pool is consistent with the following Standard
& Poor's archetypical pool assumptions for U.S. RMBS (see "Methodology And
Assumptions For Rating U.S. RMBS Prime, Alternative-A, And Subprime Loans,"
published Sept. 10, 2009):

It includes at least 250 loans;
It includes loans that are current at the time of issuance;
It includes loans with 30-year maturities; and
It includes first-lien mortgages.

The collateral pool for Sequoia 2010-H1 is not completely consistent with the
following Standard & Poor's archetypical pool assumptions (in each category, a
value of 100.00% would indicate complete consistency with these criteria):

17.55% of the loans were newly originated (within the past six months);
81.53% of the loans are secured by single-family detached residences;
19.41% of the loans are for home purchase;
26.26% of the loans are fully amortizing;
0.00% of the loans are fixed-rate; 
72.84% of the loans have no simultaneous second liens;
83.75%-93.55% of the loans appear to have FICO scores greater than or
equal to 725; and
87.35% of the loans appear to have an original combined LTV of less than
or equal to 75%.

In addition, the collateral pool for Sequoia 2010-H1 is not as geographically
diverse as Standard & Poor's archetypical pool (46% of loans are from
California, and 16% are from New York State).

The collateral pool for Sequoia 2010-H1 may or may not be consistent with the
following Standard & Poor's archetypical pool assumptions (all of the loans in
the pool would need to comply in order to be completely consistent with these
criteria):

Inclusion of loans with full appraisals (with an interior inspection) on
the secured properties;
Inclusion of loans with full underwriting and the verification of
borrower assets;
Inclusion of loans with full documentation and income verification
through IRS Form 4506T; and
Inclusion of loans with a "back-end" (which includes total debt)
debt-to-income (DTI) ratio of 36%.

For transactions with pools that are completely consistent with our
archetypical pool criteria, credit enhancement at the 'AAA' rating category
would begin at 7.50%.

COMPARISON TO OUTSTANDING PRIME JUMBO SECURITIZATIONS

Historically, Standard & Poor's has published quarterly trends reports
describing collateral characteristics for various product types (see "RMBS
Trends: Amid Volatility, U.S. Third-Quarter 2007 Prime Jumbo Securitization
Volume Is Slightly Down," published Feb. 4, 2008).

In our view, the collateral pool for Sequoia 2010-H1 appears to differ from
historical prime jumbo collateral in the following ways:

The average loan balance is higher; 
The percentage of interest-only loans is higher;
The percentage of loans for home purchases is lower;
The weighted average FICO is higher; and
The weighted average original LTV is lower.

Recourse and Non-Recourse Mortgages: Foreclosure, Bankruptcy, Policy

2010-04-27T08:39:00.000-04:00

By Ron Harris, Tel Aviv University - Buchmann Faculty of Law

Abstract: The recourse-non-recourse dimension is fundamental in any loan as it deals most directly with the pool of assets out of which lender can collect at delinquency and default. This paper calls attention to an exceptional feature of the American home mortgage market, compared to mortgage markets elsewhere in the world, the prevalence of non-recourse mortgages as created by foreclosure rules in leading states such as California and Arizona and federal bankruptcy law. It explains how the legal impediments on recourse to personal assets and future income, together with the recent drop in home prices, led to a dramatic rise in strategic foreclosures (ones that resulted from negative equity rather than from cash-flow problems). No less than 588,000 strategic walk-away mortgage defaults took place, representing nearly 20% of all foreclosures in 2008. Most of these were not likely to happen in a recourse regime.

The paper then deals with policy. It uses a few theoretical frameworks: put option, default insurance, asset partitioning and screening. It examines the pros and cons of recourse regime and of non-recourse regime. It concludes that there is no compelling justification for prohibiting either recourse or non-recourse loans. The benefits and pitfalls of a dual regime are then examined. The question relating to why we don't observe a dual regime in the real world is addressed. The paper recommends that jurisdictions that prohibit recourse loans lift this prohibition. It concludes that both recourse and non-recourse should be on the table, on the levels of regulation policy and lending practices.

Download paper here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1591524

Philly Fed: What "Triggers" Mortgage Default?

2010-04-26T16:06:00.001-04:00

Abstract: This paper assesses the relative importance of two key drivers of mortgage default: negative equity and illiquidity. To do so, the authors combine loan-level mortgage data with detailed credit bureau information about the borrower's broader balance sheet. This gives them a direct way to measure illiquid borrowers: those with high credit card utilization rates. The authors find that both negative equity and illiquidity are significantly associated with mortgage default, with comparably sized marginal effects. Moreover, these two factors interact with each other: The effect of illiquidity on default generally increases with high combined loan-to-value ratios (CLTV), though it is significant even for low CLTV. County-level unemployment shocks are also associated with higher default risk (though less so than high utilization) and strongly interact with CLTV. In addition, having a second mortgage implies significantly higher default risk, particularly for borrowers who have a first-mortgage LTV approaching 100 percent."

The paper can be downloaded here: http://www.philadelphiafed.org/research-and-data/publications/working-papers/2010/wp10-13.pdf

Force Banks to Cut Mortgage Principal: Watchdog

2010-04-20T10:42:00.000-04:00

Original posted on CNBC:

The Obama administration should consider forcing lenders to make principal reductions for struggling homeowners who owe more than their home is worth, the watchdog overseeing the $700 billion bank bailout said in a report released on Tuesday.

Late last month, the White House announced a significant expansion to its efforts to help homeowners by providing subsidies for lenders who write down principal for so-called "underwater" borrowers.

Getty Images

Those programs are voluntary.

"Treasury should consider changes to better maximize its effectiveness," said Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program, or SIGTARP.

Barofsky said the voluntary nature of the Home Affordable Modification Program (HAMP) principal reduction plan sets up situations where some borrowers benefit, while others who may be just as deserving, do not.

"Giving (mortgage) servicers the discretion to implement principal reduction introduces a questionable inconsistency into the HAMP program and stands in stark contrast to the mandatory nature of the other significant mortgage modification triggers," Barofsky wrote.

The report also urged the administration to consider extending the amount of time unemployed homeowners are forgiven from making mortgage payments as the maximum six months now allowed may not be long enough.

"Although no program will assist all unemployed borrowers, Treasury should strive for a program that will at least assist the typical unemployed borrower," the report said, noting the average duration of reported unemployment is more than 31 weeks in the latest recession, the longest stretch since records began in 1948.

Rising Tide of Foreclosures

Weakness in the housing market and high unemployment continue to weigh on the U.S. economic recovery, though consumer confidence itself is growing.

The Obama administration introduced the $75 billion homeowner assistance program in early 2009, which includes $50 billion allocated from the bailout funds.

After receiving substantial criticism from Barofsky and others, the administration announced in March a major expansion of the program, which has used just a fraction of that money.

House Financial Services Committee holds hearing on Second Liens

2010-04-20T10:40:00.000-04:00

Original posted on Lexology:

Today, the House Committee on Financial Services held a hearing entitled “Second Liens and Other Barriers to Principal Reduction as an Effective Foreclosure Mitigation Program.” Committee Chairman Barney Frank (D-MA) opened the hearing by stating that its purpose was to address the ongoing question of how to handle the home foreclosure crisis that has damaged the national economy. Mr. Frank acknowledged that the issue could not be resolved with “magic wands” or “buttons to push” but stated that a “series of efforts” have been made. Testifying before the Committee were executives representing the four largest bank-affiliated mortgage lenders, Bank of America Home Loans, CitiMortgage, Inc., JPMorgan Chase Home Lending and Wells Fargo Home Equity Group. In early March, Chairman Frank sent letters to each of the four banks urging them to adopt more aggressive principal forgiveness programs.

Appearing before the Committee were the following:

Barbara Desoer, President, Bank of America Home Loans
Jack Schakett, Credit Loss Mitigation Strategies Executive, Bank of America Home Loans
Sanjiv Das, President and Chief Executive Officer, CitiMortgage, Inc.
Steve Hemperly, Executive Vice President, Citi
Molly Sheehan, Senior Vice President, Housing Policy, JPMorgan Chase Home Lending
David Lowman, Chief Executive Officer, JPMorgan Chase Home Lending
Mike Heid, Co-President, Wells Fargo Home Mortgage
Kevin Moss, Executive Vice President, Wells Fargo Home Equity Group

Each of the witnesses provided an update on their institution's foreclosure mitigation and mortgage loan modification efforts and the status of their current initiatives under the Home Affordable Modification Program ("HAMP"). Most discussed their intent to implement the Treasury Department’s Second Lien Modification Program ("2MP").

The witnesses addressed the topic of principal reduction as an element of their loan modification programs, but urged caution in its use. Mr. Heid noted that "principal forgiveness is not an across-the-board solution" and that "we have found that principal forgiveness is best used to assist those customers [whose] homes are owner-occupied and concentrated in geographic areas with severe price declines where there is little prospect for full recovery of home values." Similarly, Mr. Lowman stated that a "broad-based program of principal reduction would be very expensive" and Ms. Desoer echoed that "we must [use principal forgiveness] in a measured, responsible way so that only customers with a legitimate hardship and genuine interest in maintaining homeownership qualify." Among other concerns, the bank executives cautioned that more aggressive principal forgiveness "could raise issues of fairness" in the eyes of other borrowers and taxpayers generally.

Ranking Member Spencer Bachus (R-AL) also expressed concerns that principal reduction could increase the cost of borrowing and the amount required for home down payments and that the financial burden of principal reduction programs would be borne by responsible taxpayers.

House Subcommittee holds hearing on recent HAMP enhancements

2010-04-20T10:38:00.001-04:00

Original posted on Lexology:

Today, the Subcommittee on Housing and Community Opportunity of the House Finance Services Committee held a hearing entitled, “The Recently Announced Revisions to the Home Affordable Modification Program” to discuss the enhancements to the Home Affordable Modification Program (HAMP) and Federal Housing Administration (FHA) program announced last month by the Treasury. Testifying before the Subcommittee were the following witnesses:

Panel 1:

David Stevens, Assistant Secretary for Housing/Federal Housing Commissioner, U.S. Department of Housing and Urban Development (HUD)

Phyllis Caldwell, Chief, Homeownership Preservation Office, U.S. Department of the Treasury

Panel 2:

Dean Baker, Co-Director, Center for Economic and Policy Research
Alys Cohen, Staff Attorney, National Consumer Law Center
Vincent Fiorillo, Trading/Portfolio Manager, Doubleline Capital LP
Andrew Jakabovics, Associate Director for Housing and Economics, Center for American Progress Action Fund
Arnold Kling, Financial Markets Working Group, Mercatus Center, George Mason University
Robert E. Story, Jr., Chairman, Mortgage Bankers Association
Alan White, Assistant Professor, Valparaiso University School of Law

Chairwoman Maxine Waters (D-CA) began the hearing by noting that while the original HAMP program helped some borrowers receive lower interest rates, the original program failed to address unemployed or underwater borrowers. Therefore, Chairwoman Waters was interested in learning how the new initiatives would address these pressing issues and what should be expected from the new initiatives. Ranking Member Shelley Capito (R-WV) noted that HAMP had fallen “woefully short” of expectations and expressed significant concerns about the program’s overpromising of assistance, noting that HAMP has provided assistance to only a fraction of the population it was designed to help.

Mr. Stevens began his testimony by emphasizing that the Obama Administration’s goal was to provide “stability for both the housing market and homeowners.” However, despite some successes, Mr. Stevens acknowledged that HAMP faced continuing challenges. Instead of attempting to assist all troubled homeowners, Mr. Stevens said that Treasury believes that HAMP should focus on helping responsible homeowners with opportunities “to obtain a modification or to refinance and prevent avoidable foreclosures and, when necessary facilitate the transition to a more sustainable housing situation.” He noted that the new FHA refinance option would “create stabilizing incentives in the housing market” by providing more opportunities for loan restructuring for borrowers who are current on their mortgage and who owe more than their home is worth. Mr. Stevens believed that HAMP was on track to offer second chances to 3 to 4 million homeowners, but acknowledged that challenges still existed before those goals could be achieved.

Responding to Chairwoman Waters’ inquiry into how the program would affect FHA reserves, Mr. Stevens noted that the option to refinance under the FHA would use currently available resources and that TARP fund would be made available if necessary to offset lender claims on defaulted loans. Therefore, according to Mr. Stevens, the new refinancing option would not expose the FHA to further risks. Finally, Mr. Stevens noted that HAMP could not permit all borrowers to avoid foreclosure and acknowledged that some borrowers will not qualify for the program. However, HAMP presents significant opportunities for homeowners assisted by the program.

Ms. Caldwell began her testimony by noting that recent modifications to HAMP were designed to assist the unemployed and underwater homeowners. Echoing Mr. Stevens’ statements that the program cannot stop every foreclosure, Ms. Caldwell emphasized that HAMP needs to focus on providing responsible homeowners opportunities “to obtain a modification or to refinance and prevent avoidable foreclosures and, when necessary, facilitate the transition to a more sustainable housing situation.” Although more than 1.4 million borrowers had been extended modification offers under the HAMP and more than 225,000 homeowners had received permanent modifications, Ms. Caldwell acknowledged that the policy and operational issues, including a complex conversion and implementation process, had been much more challenging than anticipated and that unemployment and negative equity continued to pose challenges for both homeowners and HAMP. Aggressive enhancements to HAMP, including temporary assistance for unemployed borrowers and FHA refinancing options for underwater borrowers, were implemented to assist these at-risk borrowers and to broaden the program’s impact.

Witnesses on the second panel generally shared the view that the recent modifications to HAMP remained insufficient and identified various solutions to address the current housing crisis. Mr. Baker focused his testimony on a “Right to Rent” proposal, under which Congress could change foreclosure rules to allow homeowners to remain in their homes as renters for a substantial period of time following a foreclosure. He argued that this alternative would immediately provide housing security to homeowners facing foreclosure, would not require any taxpayer dollars, and would provide the right incentive for lenders “in future market frenzies.” Ms. Cohen argued that the recently announced changes to HAMP were inadequate to address the scale of the continuing foreclosure crisis and that HAMP should be further revised to (1) increase transparency by, among other items, establishing a formal appeal process, (2) change the trial modification program’s terms to lessen adverse effects on homeowners and (3) expand the eligibility and coverage of HAMP. Mr. Jakabovics noted that the program’s biggest barrier remained “the ability of servicers to quickly and accurately modify loans” and recommended that the Treasury transfer servicing rights to those servicers who are able to meet their obligations. Mr. Story recommended implementing a waiver process, providing interest-only options for modifications to address ARMs with low interest rates, and amending the Fair Debt Collection Practices Act to permit servicers to effectively communicate with borrowers. According to Mr. White, to achieve real reductions in foreclosures and mortgage debts, the following steps are necessary: (1) enabling bankruptcy courts to write down mortgage balance for distressed homeowners, (2) rectifying the problem of junior mortgage liens and (3) addressing inadequate mortgage servicer performance.

A Critique of Mortgage Cramdown Proposals

2010-04-17T23:26:00.002-04:00

By Mark S. Scarberry, Pepperdine University School of Law

Abstract: Proposed amendments to the Bankruptcy Code permitting strip down of under secured home mortgages to the court-determined value of the homes and other modifications of home mortgages in Chapter 13 would substantially alter the risk characteristics of home mortgages, with likely substantial effects on future mortgage interest rates and future mortgage availability. Thus, the future societal cost of such a change in the law likely would be large.

This article explains and supports that thesis, primarily on the ground that the proposed changes would leave mortgage holders with all of the future downside risk in the real property market while denying them the benefit of future appreciation. This article also explains why a common argument made in favor of allowing strip down as a matter of fairness is simply mistaken; enactment of the proposed amendments would not treat home mortgages the same as other secured debt in Chapter 13 bankruptcy, but in fact would treat home mortgages much less favorably than other secured debt. Home mortgages would be the only secured debts that could be stripped down and paid off at a court-determined interest rate, with monthly payments lower than those required by the credit contract, over a period of up to nearly forty years, rather than the no-more-than-five year period that would still apply to other secured debts.

Additionally, the article provides a brief critique of Professor Adam J. Levitin's empirical studies. Even though serious flaws in his empirical studies have been pointed out, Professor Levitin continues to claim in congressional testimony that "permitting bankruptcy modification is unlikely to result in higher mortgage costs or lower mortgage credit availability." Supporters of strip down in Congress continue to rely heavily on Professor Levitin’s studies as showing that the proposed changes in the law would not substantially affect mortgage interest rates or mortgage availability.

Unfortunately, Professor Levitin's empirical studies, though thoughtful and creative in their design, rely on incorrect understandings of current and past bankruptcy law and of the proposed legislation. They, in effect, compare apples with oranges - or perhaps a bumper crop of apples with a frost-ravaged crop of oranges - by comparing the effects of the kind of strip down that would be widely available under the legislation now before Congress, with the effects of the very different kinds of strip down that, in limited circumstances, are currently available or were at one time available. His studies also fail to take into account the very different incentives that the proposed legislation would create were it to be enacted, both in terms of encouraging debtors with large negative equity to file Chapter 13 bankruptcy petitions and encouraging Chapter 13 debtors to argue for a low value for their homes rather than to report an inflated value. The empirical studies thus do not provide a solid foundation for the making of public policy.

In addition, adoption of the proposed amendments to the Bankruptcy Code would cause somewhat perverse results. Strip down provides the greatest benefit to debtors who have the greatest amount of negative equity. Homeowners who made the lowest down payments, paid the most inflated prices for their homes, and refinanced to take equity out of their homes for purposes of consumption thus would receive the greatest benefits - benefits that would include, in essence, a free option on future appreciation and that would not be well calibrated to the homeowners' financial need - while homeowners who made large down payments, were careful not to pay inflated prices, and did not use their home equity to finance consumption would receive the least benefits.

These perverse results are not only undesirable in and of themselves from a public policy "moral hazard" perspective. They also may cause resentment among those persons who could not benefit from them or who would receive a perversely smaller benefit were they to encounter financial distress and need bankruptcy assistance. In the longer term, such resentment may undermine public support for the primary function of consumer bankruptcy laws: "to grant a fresh start to the honest but unfortunate debtor".

On the other hand, homeowners with substantial negative equity may have little incentive under current law to continue to make mortgage payments. We could expect then that if many homeowners have substantial negative equity, the rate of foreclosures on home mortgages will be high. A high rate of home foreclosures in turn helps to further depress the market prices of homes, harming not only mortgage holders whose homes are sold in foreclosure at low prices, but also homeowners who have faithfully paid their mortgages and whose home values drop when foreclosure strikes nearby homes. Thus, the foreclosures that occur due to negative equity have an indirect effect on the wealth of homeowners who have not defaulted on their mortgages. On a broader scale, the effect may be a downward spiral in which negative equity causes a high foreclosure level, which causes home prices to drop, which creates additional negative equity, which then causes foreclosure levels to remain high, which causes home prices to drop further, and so on. It is possible that steps taken to reduce the levels of negative equity, including allowing homeowners to strip down their mortgages, could help stop the spiral, help home values stabilize, and help bring the current high foreclosure rate back to a historically normal level.

But how could this be accomplished without causing unacceptable effects on future mortgage affordability and availability, without creating perverse results, and without triggering substantial resentment? First, any legislation that permits strip down should include a strong provision for recapture by the mortgage holder of a substantial portion of any future upturn in the value of the home. Such a provision would minimize the effect of strip down on the risk characteristics of mortgages by preserving for mortgage holders most of the benefit of a future upturn in the market for homes. It would also minimize the perverse effects of strip down by denying the homeowner the free option on future appreciation that strip down otherwise would provide, and it would, as a result, help to minimize resentment. Second, any such legislation should have clear eligibility criteria designed to minimize the negative effects that likely otherwise would occur. And third, alternatives should be considered to the kind of strip down that the current legislative proposals would permit, perhaps alternatives based on approach taken in the Obama administration's program for modification of home mortgages, the Home Affordable Modification Program. Any such legislation should limit home mortgage modification to mortgages originated prior to January 1, 2008, by which time it had become very clear that the nation had entered a serious mortgage crisis, such that Congress was actively considering legislation to deal with the crisis, including home mortgage strip down legislation.

Download paper here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1520794

Response from Adam J. Levitin, Georgetown University Law Center:

Abstract: Professor Mark Scarberry has put forth a formidable critique of my empirical study of mortgage market sensitivity to bankruptcy modification risk. As this response shows, however, his critique does not hold up under scrutiny.

Professor Scarberry argues that my study design is invalid because, as he reads the current state of the law, cramdown is virtually impossible. Therefore, he contends, we should not expect markets to exhibit sensitivity to cramdown risk, so no policy conclusions can be derived from my finding of market insensitivity.

Regrettably, Professor Scarberry overreads the state of the law. The law is in fact unsettled, and that is all that is necessary to uphold the validity of my study’s design because the market can be expected to price for uncertainty about the law, and the absence of such a premium is significant.

This response article also challenges Professor Scarberry’s contention that Chapter 13 relief should be limited lest it engender “resentment” of debtors. The article questions whether prevention of resentment even provides a sound basis for limiting bankruptcy relief, much less when relief would further an important macroeconomic goal of housing market stabilization.

More broadly, the article takes issues with claims about the sanctity of secured credit. Debates about the efficiency of secured credit have all played out in the business context. In the consumer context, however, the inefficiency is manifest. Treating secured credit as inviolable would take us back to the unhappy future of Chapter XIII with higher costs for unsecured credit and the abusive consumer finance world of Williams v. Walker-Thomas.

Download response here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1534912&rec=1&srcabs=1520794

Wells Fargo Analysis: 50% Fail HAMP Eligibility

2010-04-17T00:04:00.000-04:00

Original posted on eCreditDaily.com:

Wells Fargo has 523,336 borrowers either in trial or approved mortgage modifications as of March 31, more of them as part of the lender’s own foreclosure prevention efforts.

Of those, 144,932 are part of the government’s Home Affordable Modification Program, HAMP, with active trial and completed modifications, also as of March 31.

Wells Fargo, which services about 16 percent of U.S. mortgages, said it initiated or completed three modifications for every one foreclosure sale on owner-occupied properties from October 2009 through March 2010.

In a statement providing an update on its foreclosure prevent efforts, Wells Fargo offered a glimpse into its analysis of the HAMP program’s troubled rate of assistance, with as many borrowers falling eligibility as those approved for the full term of mortgage relief.

Wells Fargo said half of the 138,000 homeowners who have made three HAMP trial payments as of March 31, will be offered modifications for the full term. Of the rest, 30 percent are expected to be deemed not eligible after documents are received, and another 20 percent will not provide some or all required documents.

The U.S. Treasury released HAMP’s March update Wednesday.

Overall, HAMP’s approved modifications for its five-year reduced-payment term is up to 227,922 borrowers, representing about 19 percent of all trials started. The program’s number of borrowers whose trial or approved modifications have been cancelled because of default or other reasons is 158,052 borrowers – about 13 percent of those who started trial modifications.

“HAMP is the starting point in our efforts to help borrowers facing financial challenges, but we been very successful in finding other workout options when a customer is not eligible for HAMP,” said Mike Heid, co-president of Wells Fargo Home Mortgage.

On April 5, Wells Fargo initiated its part in HAMP’s new Home Affordable Foreclosure Alternatives (HAFA) program, which provides incentives to servicers and borrowers who work on short sales or deed-in-lieu of foreclosure. Although all parties have to agree on the terms and short sale price, HAFA provides principal forgiveness on leftover mortgage balances.

Heid and counterparts at other top lenders testified this week before a House panel seeking feedback on HAMP’s expansion plans into principal forgiveness. The mortgage servicing executives expressed some reservations about the fairness and expense of mortgage writedowns.

Nonetheless, Heid said that Wells Fargo had initiated writedowns before HAMP was launched in 2009. The lender completed more than 50,000 modifications, with a total reduction in principal of more than $2.6 billion.

“On average, customers received a 15 percent reduction in principal amounting to greater than $50,000, and when combined with rate reductions and term extensions their average monthly payments dropped by 25 percent under the terms of their loan modification agreements,” Heid said.

When right-to-rent meets principal reduction

2010-04-15T18:16:00.000-04:00

Original posted on Reuters by Felix Salmon:

What happens when you cross right-to-rent with mortgage principal reductions, and turn the whole thing into an entirely voluntary private-sector program with no government involvement whatsoever? It might look a little bit like American Homeowner Preservation, a for-profit company which has a very interesting idea for keeping people in their homes.

The details can be found here: the core of the scheme is where AHP persuades a lender to accept a short sale on a home. That’s the principal-reduction bit; the right-to-rent bit then kicks in when the buyer of the home — an AHP client, along with the seller — agrees to rent back the home to the former owner at a low, affordable rate which can’t be more than one-third of the tenant’s income. Rent increases by 5% annually for five years; at any point, the tenant has the option to buy back the home at a predetermined price which rises year by year; tenants get financial counseling to enable them to do that.

The buyer can sell the home at any point in the first five years subject to the existing lease and option; after that, it’s put on the market and any profits over and above the option price get split equally between the buyer and the tenant.

If everything goes according to plan, the buyer makes healthy returns: here’s one financial projections sheet which foresees returns in the low double digits. And the homeowner ends up buying back their own home for much less than they originally bought it for. Meanwhile, AHP makes relatively modest fees of a few thousand dollars along the way.

I don’t know much about American Homeowner Preservation, and their website could use a bit of work. But in principle, I think there’s a very good idea here. Any bank dealing with AHP is going to want to make very sure they’re getting a genuine market rate for the house in question, but so long as that’s the case, and the bank is open to short sales in principle, this looks like a win-win for all concerned. The owner gets to stay in their house, the bank gets to avoid the expense of foreclosure proceedings, and the investor gets decent returns. Clever!

BoA and Chase on Second Mortgages

2010-04-15T00:07:00.001-04:00

Original posted on Calculated Risk by Tom Lawler:

In a House Financial Services Committee meeting today on “Second Liens and Other Barriers to Principal Reduction as an Effective Foreclosure Mitigation Program, spokespersons from BoA, Citi, JPMorgan Chase, and Wells Fargo explained the potential dangers of broad principal reductions, as well as tried to dismiss the silly claim that many second mortgages have “virtually no value” because so many borrowers with seconds have total mortgage balances at or exceeding the value of the home collateralizing those mortgages. Below are some observations on BoA’s and Chase’s testimony.

BoA provided a few interesting stats: of the 10.4 million first lien mortgages that it services, 15% of second mortgages owned by BoA, while 16% have second mortgages with other lenders. (Thus, 31% have second liens!).

BoA also said that about 90% of BoA’s owned second-lien mortgage portfolio is made up of “standalone originations used to finance a specific customer need, such as education expenses or home improvements, with “(t)he remainder consists of piggy back (combo) loans originated with the home purchase.” BoA made this point to highlight that the vast bulk of its second mortgage lending was collateralized consumer credit lending, where the borrower’s ability to pay was a major factor behind extending the credit.

Here is what BoA said about their second mortgage portfolio:

“Most of our second loans continue to have collateral value, and of those where the second loan is underwater, a significant number are still performing. Indeed, out of 2.2 million second liens in Bank of America’s held for investment portfolio – only 91,000 seconds – about four percent – are (i) delinquent, (ii) behind a delinquent first mortgage and (iii) not supported by any equity.”

BoA’s spokesperson vexed a number of investors in first-lien mortgages (or securities backed by such mortgages) by saying that in cases where the first and second are held by different investors, the “logic of 2MP” (the administrations second mortgage program) where “the holder of the second lien is required to forebear a similar percentage as the first lien holder” seems “equitable” to BoA – despite the subordinate nature of the second, and despite the fact that the 2MP program does not require second mortgage holders to forgive principal, even when the first mortgage holder does!

Here is what Chase said about its Home Equity (second) mortgage portfolio:
Chase owns about $131 billion in Home Equity loans and lines as of February 28, 2010.

• Approximately $25 billion are home equity loans and $106 billion are home equity lines of credit.
• Approximately $33 billion are in first lien position and $98 billion in second lien position.
• 5% of Chase’s home equity portfolio is 30 days or more delinquent. Total home equity line, home equity loan, first lien and second lien delinquency rates are within two percentage points of the overall total.
• About 50% of the total Chase second lien portfolio is underwater, and 95% of this portfolio is performing (less than 60 days past due). 30% of second lien mortgages have combined loan-to-value ratios over 125% and 94% of this portfolio is performing.
• For $40 billion of Chase-owned second lien mortgages, Chase also services a first lien mortgage:
• 92% of these first lien mortgages are performing.
• 28% of these first lien mortgages are by themselves underwater (loan- to-value ratio of over 100%).
• 45% of first lien mortgages have a combined loan- to-value ratio of over 100%.
• About 10% of Chase’s total serviced portfolio of first lien mortgage loans has a Chase-owned second lien.
• Our best estimate is that about 20% of Chase serviced first lien mortgages may have a second lien from another lender and about 70% do not have a second lien.

And on the issue of broad-based principal reduction programs, as well as the “subordinate” nature of second mortgages, here is what Chase had to say:

“We do think that large scale, broad–based principal reduction programs raise serious policy concerns, for both first and second lien mortgage loans, and particularly for current borrowers with an ability to repay their obligations. In Chase’s view, such programs could be potentially very harmful to consumers, investors and future mortgage market conditions – and should not be undertaken without first attempting other solutions, including more targeted modification efforts.

“Like all loans, mortgage contracts are based on a promise to repay money borrowed. Importantly, there is no provision in the mortgage contract, express or implied, that the lender will restore equity or reduce the repayment amount if the value of the collateral – be it a home, a car or a stock market investment – depreciates. If we re-write the mortgage contract retroactively to restore equity to any mortgage borrower because the value of his or her home declined, what responsible lender will take the equity risk of financing mortgages in the future? What responsible regulator would want lenders to take such risk?

“We are also concerned that broad-based principal reduction could result in reduced access to credit and higher costs for consumers if market risk to lenders and investors materially increases. Borrowers likely will be required to increase their down payments, credit criteria will be further tightened and risk premiums for mortgage credit will increase and get passed on to consumers. Less affluent borrowers would likely be harmed disproportionately.

“The benefits of a broad-based principal reduction program are to a large degree unknown and in Chase’s view, outweighed by the risks and the facts that we do know.”

And here is Chase on why many second loan portfolios are performing better than firsts, as well as the risks involved in broad-based principal reduction plans:

“Many borrowers remain current on their home equity loans because they want to honor their obligations and protect their credit. Our data show that 97% of borrowers in Chase’s $98 billion second lien portfolio are performing on their loans (less than 60 days past due). For second liens that have a cumulative loan-to-value ratio greater than 100%, 95% of borrowers are performing. Regardless of loan-to-value, as long as borrowers continue to do the right thing and fulfill their contractual obligations, second liens that are current and producing cash flow to investors have value."

“Additionally, a broad-based second-lien principal reduction plan would be forgiving past consumption by borrowers rather than housing investment. According to both internal Chase and Federal Reserve data, over 50% of borrowers used home equity loan proceeds for repayment of debt or personal consumption. No more than 15-20% used home equity proceeds to purchase a home. A broad-based program of principal reduction would be very expensive. To bring underwater borrowers “even” to a loan to value ratio of 100%, we estimate:

• It would have an industry-wide cost of $700 billion to $900 billion.
• The cost to Fannie Mae, Freddie Mac and FHA alone would be in the neighborhood of $150 billion.
• The Federal Reserve and Department of Treasury would have additional exposure through their ownership interests and risk guarantees of AIG, GMAC, and other institutions.
• Mortgage lenders would incur a significant reduction in capital now, potentially impairing their ability to extend future credit – mortgage or otherwise.
• And if house prices decline further, the costs would be even higher, representing the implicit “put” at 100% CLTV. “

And on the issue of LIEN priority, here is what Chase had to say:

“It is important not to confuse payment priority with lien priority. In almost all scenarios, second lien holders have rights equal to a first lien holder with respect to a borrower’s cash flow. The same is true with respect to other secured or unsecured debt, such as credit cards or car loans. Generally, consumers can decide how they want to manage their monthly payments. In fact, almost 64% of borrowers who are 30-59 days delinquent on a first lien serviced by Chase are current on their second lien. It is only at liquidation or property disposition that first lien investors have priority.”

The banks’ testimony, of course, was in response to a letter from Barney Frank, who has been heavily lobbied (and influenced) by the Mortgage Investors Coalition to get second mortgage holders to write down their loans. In that letter Congressman Frank incorrectly argued that because many borrowers with second mortgages have total mortgage indebtedness that exceeds the value of their homes, these second mortgages “have no real economic value,” and he urged banks “in the strongest possible terms to take immediate steps to write down these second mortgages.”

Here, by the way, are some residential mortgage servicing statistics as of the end of last year for the top four mortgage servicers:

12/31/2009		Delinquency Stats: Q4/09
Company Name	Number of Loans Serviced¹	30-day	60-day	90+-day	In Foreclosure	Total Past Due
Bank of America	14,011,029	3.4%	1.7%	6.5%	3.3%	14.8%
Wells Fargo	12,168,836	2.4%	1.2%	3.5%	1.9%	9.0%
Chase	9,689,312	3.0%	1.4%	4.6%	3.2%	12.2%
CitiMortgage, Inc.	5,118,563	2.3%	1.4%	4.9%	1.7%	10.4%

¹ includes first liens and subordinate liens

These “mega” servicers were, through the economies of scale in processing payments, able to charge a pretty small fee to service loans and still make what appeared to be a decent amount of money. However, as problem loans mounted it became clear that the companies were woefully understaffed to deal with these problem loans effectively, leading to extremely poor loss mitigation efforts, poorly designed foreclosure prevention/modification programs.

All of these companies finally began materially increasing the size of their staffs devoted to troubled loan management, and the administration’s HAMP effort helped prompt them to do so by providing hefty premiums to servicers. However, it took companies quite a while to get staff and board and train them, as was clearly evidence in last year’s overall servicing performance.

Bank of America now supports bankruptcy cramdowns

2010-04-14T14:21:00.001-04:00

Original posted on the Huffington Post:

Bank of America, the nation's largest lender and its biggest bank by assets, now supports changing the law to give federal judges the power to modify mortgages in bankruptcy.

The bank joins Citigroup, the nation's third-largest bank by assets, in supporting a change to existing law to give homeowners more leverage. Unlike other forms of debt, bankruptcy judges presently lack the power to change mortgage terms. The banking and home mortgage industry want to keep it that way -- by not allowing judges the authority to change the terms, troubled homeowners are at the mercy of their lenders. They take what they get.

But Tuesday, before a nearly-empty Congressional hearing room, Barbara J. Desoer, president of Bank of America Home Loans, said her bank now supports leveling that playing field.

"As we've gone through the lessons that we've learned with modifications and other programs, there probably is some segment of borrowers for whom that would be an appropriate alternative," Desoer said before the House Financial Services Committee.

"So you would support that in some circumstances?" asked Rep. Brad Miller (D-N.C.) in a follow-up to his original question.

"In some circumstances, yeah," Desoer responded.

How loan servicers milk the foreclosure-prevention program

2010-04-14T13:33:00.000-04:00

Original posted on Reuters by Felix Salmon:

If there’s one consistent villain in the tale of attempts to minimize home foreclosures, it’s the loan servicers. They lose paperwork, they foreclose on homes they have no right to foreclose on, they accept borrowers into modification programs while trying to foreclose on them at the same time, they deny borrowers a modification even when they shouldn’t, they’re impossible to get ahold of, their communication with borrowers is atrocious, they claim to be owed vastly more money than they actually are owed, and so on and so forth.

Which is why it’s so depressing that servicers are actually the biggest winners of the way that the government is doing mortgage modifications — at the expense of homeowners, no less. Shahien Nasiripour, who is not giving up in his attempt to push principal reduction as a solution to the mortgage-modification problem, finds this in the latest COP report:

“HAMP’s original emphasis on interest rate reduction, rather than principal reduction, benefits lenders and servicers at the expense of homeowners,” the report reads. “Lenders benefit from avoiding having to write down assets on their balance sheets and from special regulatory capital adequacy treatment for HAMP modifications. Mortgage servicers benefit because a reduction in monthly payments due to an interest rate reduction reduces the servicers’ income far less than an equivalent reduction in monthly payment due to a principal reduction.

“Servicers are thus far keener to reduce interest rates than principal. The structure of HAMP modifications favors lenders and servicers, but it comes at the expense of a higher redefault risk for the modifications, a risk that is borne first and foremost by the homeowner but is also felt by taxpayers funding HAMP.”

The report explains:

Servicers’ primary compensation is a percentage of the outstanding principal balance on a mortgage. Thus, principal reductions reduce servicers’ income, whereas interest reductions do not, and forbearance and term extensions actually increase servicers’ income because there is greater principal balance outstanding for a longer period of time.

It’s worth noting here that another set of losers in this set-up is the people who bought mortgage-backed securities. Banks benefit from this system because they don’t need to write down their mortgages, and because they often own servicers. But investors in mortgages mark to market: they have no choice when it comes to taking losses. And when a servicer keeps the principal amount high and the interest amount low, that just means that the owner of the mortgage pays unnecessary extra money to the loan servicer.

That’s true of private mortgage investors at mutual funds and hedge funds — but it’s also true of the biggest mortgage investors of them all, Fannie Mae and Freddie Mac. Is it too much to hope that they might start pressuring the government to force more principal reductions?

Updated HAMP FAQs issued

2010-04-14T09:44:00.000-04:00

Click here for the general FAQs and here for the Conversion Campaign FAQs.

US Treasury Seeks Public Input on Reform of the Housing Finance System

2010-04-14T09:42:00.001-04:00

WASHINGTON - The Obama Administration today released questions for public comment on the future of the housing finance system, including Fannie Mae and Freddie Mac, and the overall role of the federal government in housing policy. The questions have been designed to generate input from a wide variety of constituents, including market participants, industry groups, academic experts, and consumer and community organizations. The questions will also be published in a Federal Register notice requesting public comments, and information on the process for submitting comments will be included in that notice.

"A well-functioning housing finance system is critical to the long term stability of the housing market," said Treasury Secretary Tim Geithner. "Hearing from a wide variety of perspectives as we embark on this process is an important part of establishing a more stable and sound housing finance system for the American people."

"This open process will help shape the future of our housing finance system," said U.S. Housing and Urban Development (HUD) Secretary Shaun Donovan "The Obama administration is committed to engaging the public as we consider proposals for reforming the housing finance system in the context of our broader housing policy goals, and the best steps to get from where we are today to a stronger housing finance system."

The Obama Administration will seek input in two ways. First, the public will have the opportunity to submit written responses to the questions published in the Federal Register online at www.regulations.gov. Second, the Administration intends to hold a series of public forums across the country on housing finance reform. Together these opportunities for input will give the public the chance to deepen the federal government's understanding of the issues and to shape the policy response going forward.

This effort is both in keeping with this Administration's commitment to openness and transparency and the President's Open Government Initiative. This initiative represents a major change in the way federal agencies interact with the public by making agency operations and data more transparent and creating new ways for citizens to have an active voice in their government.

Questions for Public Solicitation of Input:

1. How should federal housing finance objectives be prioritized in the context of the broader objectives of housing policy?

Commentary could address: policy for sustainable homeownership; rental policy; balancing rental and ownership; how to account for regional differences; and affordability goals.

2. What role should the federal government play in supporting a stable, well-functioning housing finance system and what risks, if any, should the federal government bear in meeting its housing finance objectives?

Commentary could address: level of government involvement and type of support provided; role of government agencies; role of private vs. public capital; role of any explicit government guarantees; role of direct subsidies and other fiscal support and mechanisms to convey such support; monitoring and management of risks including how to balance the retention and distribution of risk; incentives to encourage appropriate alignment of risk bearing in the private sector; mechanisms for dealing with episodes of market stress; and how to promote market discipline.

3. Should the government approach differ across different segments of the market, and if so, how?

Commentary could address: differentiation of approach based on mortgage size or other characteristics; rationale for integration or separation of functions related to the single-family and multi-family market; whether there should be an emphasis on supporting the production of subsidized multifamily housing; differentiation in mechanism to convey subsidies, if any.

4. How should the current organization of the housing finance system be improved?

Commentary could address: what aspects should be preserved, changed, eliminated or added; regulatory considerations; optimal general organizational design and market structure; capital market functions; sources of funding; mortgage origination, distribution and servicing; the role of the existing government-sponsored enterprises; and the challenges of transitioning from the current system to a desired future system.

5. How should the housing finance system support sound market practices?

Commentary could address underwriting standards; how best to balance risk and access; and extent to which housing finance systems that reference certain standards and mortgage products contribute to this objective.

6. What is the best way for the housing finance system to help ensure consumers are protected from unfair, abusive or deceptive practices?

Commentary could address: level of consumer protections and limitation; supervising agencies; specific restrictions; and role of consumer education

7. Do housing finance systems in other countries offer insights that can help inform US reform choices?

75% In HAMP Still Owe More Than Their Homes Are Worth

2010-04-14T09:30:00.003-04:00

Original posted on the Huffington Post by Shahien Nasiripour:

More than three-quarters of homeowners who have had their monthly mortgage payments reduced under the Obama administration's primary foreclosure-prevention program owe more on their mortgage than their house is worth, according to a new report by government auditors.

Download the report here: http://cop.senate.gov/documents/cop-041410-report.pdf

Over half of the roughly 170,000 distressed borrowers who have gone through the program are seriously underwater, meaning they have negative equity of at least 25 percent, the report shows, citing data through February. In other words, for every $1.00 their home is worth, they owe at least $1.25.

The average homeowner that's received a five-year modified mortgage under the administration's plan had negative equity of about 35 percent prior to the program, according to a Wednesday report by the Congressional Oversight Panel, a federal bailout watchdog. After modification, that burden actually increased for the average homeowner, who is now underwater by more than 43 percent, according to the bailout watchdog's report. Research shows that the more under water homeowners are, the more likely they are to fall behind on payments, default, or walk away.

But that data understates the problem, the report said. Those figures are for first-lien home mortgages only. Debt owed on junior liens, like second liens and home equity lines, isn't part of that calculation. The Obama administration estimated last April that "up to 50 percent of at-risk mortgages currently have second liens."

"If junior liens were to be included, the percentage would be significantly higher," the report notes. "The continuing deep level of negative equity for many HAMP permanent modification recipients makes the modifications' sustainability questionable; even with more affordable payments, deeply underwater borrowers may remain tempted to strategically default or may be compelled to because core life events, such as death, divorce, disability, marriage, child birth, job loss, or job opportunities necessitate a move."

HAMP refers to the administration's Home Affordable Modification Program, which seeks to lower troubled borrowers' monthly payments primarily through interest rate cuts. Strategic defaults occur when homeowners are able to make the payments, yet willingly choose not to and instead walk away from the mortgage. Recent research estimates strategic defaults are on the rise.

"Negative equity is the single most important driver of defaults," Laurie S. Goodman, senior managing director at Amherst Securities and a top mortgage bond analyst, said in February during a panel discussion at the American Securitization Forum's annual conference.

After months of sustained criticism -- including by the bailout watchdog and by Democrats in Congress -- the Treasury Department finally outlined a plan late last month that calls for principal reductions, which is the only way to address the problem posed by underwater homeowners. (Absent a rise in property values, the only way to give borrowers equity is to reduce the overall amount owed). But that plan doesn't kick in until the fall. Meanwhile, the foreclosure crisis does not show any signs of abating, the panel's chair, Harvard Law professor Elizabeth Warren, said during a Tuesday evening conference call with reporters.

Her panel's report notes that "principal forbearance was rare and principal forgiveness rarer still." Deferred principal accounted for about 28 percent of the mortgage modifications, while "only" six percent of them involved principal cuts. An additional six percent incorporate principal cuts and deferred principal.

"[T]he Panel has concerns as to whether the modifications make homeownership sufficiently affordable to avoid foreclosure, given borrowers' broader circumstances. As noted previously, the program...without considering the existence of junior liens, leaves borrowers still paying a significant percentage of their income for housing," the report notes. "This is particularly problematic because most HAMP modification recipients are underwater.

"This points to the problem with the lack of principal forgiveness in HAMP up to this point. Lack of principal forgiveness means that homeowners will continue to be underwater. It also means that more of each payment will be going to interest, rather than paying down principal, and it may mean that some borrowers have to pay for a longer period of time. All of these factors increase the re-default risk on modified mortgages, and to the extent that a permanent modification is not sustainable, it merely delays a foreclosure and the stabilization of the housing market."

Less than a quarter of eligible homeowners have converted from temporary trial modification plans into five-year plans, the report notes. Treasury originally forecast up to a 75 percent conversion rate. And while it's too early to tell the rate at which these modified loans will default, Treasury estimates a 40 percent re-default rate, the report notes, citing testimony from Treasury officials. The administration originally promised to help three to four million homeowners avoid foreclosure.

The panel estimates that in the end as few as 276,000 foreclosures will be averted. Last year lenders foreclosed on more than 2.8 million homes, according to real estate research firm RealtyTrac. The firm estimates three million homes will get foreclosure notices this year; more than one million of them will be repossessed by lenders.

"For every borrower who avoided foreclosure through HAMP last year, another 10 families lost their homes. It now seems clear that Treasury's programs, even when they are fully operational, will not reach the overwhelming majority of homeowners in trouble," the panel's report notes.

In an e-mail to reporters, Treasury spokeswoman Meg Reilly said that the department's latest monthly report on HAMP will show that more than 230,000 homeowners have transitioned into five-year modification plans. Additional 108,000 have been approved and are awaiting borrower acceptance. The report is expected to be released Wednesday, Reilly wrote.

One issue that's been pondered by investors and housing analysts, but hasn't been fully addressed by policymakers is the supposed backdoor-bailout nature of the HAMP program. While it's supposed to help homeowners, many have criticized its design as benefiting the mortgage servicers instead. The four biggest mortgage servicers are the four biggest banks -- Bank of America, JPMorgan Chase, Citigroup and Wells Fargo -- and taxpayers pay them for every successful modification. Also, because those modifications rely primarily on interest rate cuts, rather than principal writedowns, they end up increasing troubled homeowners' amount of overall debt, according to the panel's report.

"HAMP's original emphasis on interest rate reduction, rather than principal reduction, benefits lenders and servicers at the expense of homeowners," the report reads. "Lenders benefit from avoiding having to write down assets on their balance sheets and from special regulatory capital adequacy treatment for HAMP modifications. Mortgage servicers benefit because a reduction in monthly payments due to an interest rate reduction reduces the servicers' income far less than an equivalent reduction in monthly payment due to a principal reduction.

"Servicers are thus far keener to reduce interest rates than principal. The structure of HAMP modifications favors lenders and servicers, but it comes at the expense of a higher redefault risk for the modifications, a risk that is borne first and foremost by the homeowner but is also felt by taxpayers funding HAMP."

Treasury allocated $50 billion to help struggling homeowners, and an additional $25 billion for government-backed housing giants Fannie Mae and Freddie Mac. The nation's four biggest banks by assets received a combined $140 billion alone in initial taxpayer bailout money.

"Foreclosure prevention is not just the right thing do for suffering Americans, but it is the linchpin around which all other efforts to achieve financial stability revolve," said Richard H. Neiman, New York's top bank regulator and a member of the Congressional Oversight Panel.

Over the past two months alone more than 450,000 homes have received a foreclosure notice. Slightly more than 100,000 homeowners have been helped by Treasury's anti-foreclosure efforts over the same time period.

"In the final reckoning, the goal itself seems small in comparison to the magnitude of the problem," the panel said in its report.

*Source: Congressional Oversight Panel

Musings on mortgage modification-obfuscation

2010-04-14T07:24:00.000-04:00

Original posted on FT Alphaville by Tracy Alloway:

Here’s something to ponder ahead of the US bank earning season.

Mortgage modifications — that is, changes to the terms of home loans — have been running rampant just as banks’ non-performing loans and net-charge-offs appear to be peaking. Coincidence?

Banks like JP Morgan, Citigroup and Wells Fargo are very large mortgage servicers and underwriters, which means they’re at the forefront of these modification efforts, including the US Treasury’s Hamp programme. Many of the loans they underwrite have been sold on to securitisations, or to the two Government-Sponsored Enterprises, Fannie Mae and Freddie Mac.

Mortgage modifications aren’t really a problem as long as they’re transparent; they clearly show up in the servicers’ and investors’ books. The problem, however, is that that’s not always the case.

From mortgage analyst Laurie Goodman, and team, at Amherst Securities:

[Non-Hamp] Modification payment records are often incomplete. It is not unusual for the servicer or trustee to report the new interest rate, but not specify how long the new rate will last. When this is done, Intex [the biggest provider of securitisation modeling software in the US] assumes it is only good until the next reset unless the user specifies otherwise. In reality, many ARMs are converted to fixed rates, with the reduced rate good for 5 years or longer.

There are many situations in which a modification is suspected—the rate changes, there is a capitalization event, principal balance changes etc, but no modification is reported. In this case, Intex labels the loan a “suspected modification” but does not use this information. Users can go in manually loan by loan and change the assumptions.

Besides the transparency problem, not reporting that a loan was modified has obvious implications for reported cash flows from the bond. According to Amherst:

Consider a simple, one loan example. Assume the loan has been modified to a 5% fixed rate. Meanwhile Intex is assuming that the ARM is rolling to LIBOR +600; forward LIBOR is 4.3% 3 years out. Thus, the cash flows are being calculated off a note rate of 10.3%, versus an actual coupon rate of 5%. In a deal in which credit enhancement is provided, in part, by excess spread and overcollateralization, the model would assume that after paying the coupon, the remainder of the cash flows are available to absorb losses. Hence, without consideration of the modification, this loan would be making a large contribution to the absorption of losses; with the modification (using forward rates for the analysis), the contribution would be very low.

Placing non-Hamp mortgage modifications to one side, there still seems to be a degree of uncertainty as to how to treat those forborne (modified) cash flows. The US Treasury says that for Hamp modifications, at least, altered loans within securitisations should be treated as realised losses.

That is, the amount of principal forbearance should be treated as a loss.

But there still appears to be some interpretation taking place.

From Amherst:

In fact, at least one large servicer is still not treating forbearance as a realized loss. This has implications for cash flow allocation within the deal. If the cash flows are treated as a realized loss, the junior tranches will be written down more quickly.

Second Mortgages Vex Borrowers

2010-04-11T22:54:00.000-04:00

Posted in the WSJ by James Hagerty:

After losing her condo in San Diego to foreclosure last year, Charissa Kolich thought that at least she was free of mortgage bills.

But Wells Fargo & Co., which holds a home-equity loan made five years ago to Ms. Kolich, last month filed a lawsuit against her in the Superior Court of California, San Diego County, seeking to collect the nearly $72,000 it said she still owed on that second mortgage. "This was all kind of a shock," says Ms. Kolich, a food-service administrator recently diagnosed with inoperable brain cancer.

Banks are coming under increasing political pressure to write off or at least write down second-lien and other junior mortgages as a way to help borrowers keep their homes or extract themselves from heavy debt. As the Wells Fargo suit shows, however, banks often are reluctant to give up on loans when they see a chance of recovering all or part of their money.

This issue will be the focus of a hearing Tuesday by the House Financial Services Committee in Washington. Panel members are due to quiz executives from Wells Fargo, Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co. about their junior-lien mortgage policies.

Why do junior-lien mortgages matter? The $1 trillion of junior-lien mortgages outstanding in the U.S. at the end of 2009 added up to only about 10% of total home-mortgage debt, according to Federal Reserve data. But many banks have large holdings of these junior liens. Among borrowers whose first mortgages were packaged into so-called private-label securities (those not backed by any government entity), about half also have junior-lien loans, according to mortgage-bond trader Amherst Securities.

Those junior liens now represent one of the trickiest obstacles to efforts to get distressed borrowers back on their feet. Borrowers who negotiated lower payments on their first mortgages often find they are overwhelmed by payments on second mortgages and other debts.

The owners of first-lien mortgages (mostly investors in mortgage securities) are reluctant to reduce payments or cut principal for troubled borrowers unless holders of the junior liens (mostly banks) also take a hit. But banks, struggling to rebuild their capital, don't want to write off any more junior liens than they must.

Many junior liens lack collateral backing because home values have fallen below the amount owed on just the first mortgage. "Large numbers of these second liens have no real economic value," Barney Frank, a Massachusetts Democrat who is chairman of the House Financial Services Committee, said in a recent letter to the big banks. He added: "I urge you in the strongest possible terms to take immediate steps to write down these second mortgages."

But many people who have fallen behind on their first mortgages are still making payments on their junior liens, and banks say they shouldn't have to write down loans that are performing.

Even in cases where a foreclosure or related action has turned a junior-lien mortgage into an unsecured loan, lenders may still be able to collect, though state laws vary on this point. Leo Stawiarski Jr., a lawyer in Englewood, Colo., who advises banks, says they should assess each borrower's ability to repay any second mortgage after a foreclosure. For borrowers who have sufficient income or other assets, or are likely to have the means in the future, banks should try to negotiate a settlement involving at least partial repayment, he says. If borrowers refuse to cooperate, lenders in some cases can garnish their wages or other assets.

Mr. Stawiarski believes banks should, and eventually will, become more aggressive in pursuing these claims. "I think lenders are really leaving a lot of money on the table," he says. One option for banks is to sell junior-lien loans to collections firms, which can then pursue borrowers.

Representatives of J.P. Morgan Chase and Citigroup declined to comment on their junior-lien collection policies. A spokeswoman for Bank of America said that if efforts to avoid a foreclosure failed, "then we do reserve the right to recover the unpaid balance on the second lien if permissible by state law. However, our practice has been to only to pursue recovery in situations where we believe the customer has sufficient nonretirement assets to satisfy their debt obligation."

In response to questions about the suit Wells Fargo filed against Ms. Kolich, a Wells spokeswoman said: "We consider customer hardships on a case-by-case basis and we would welcome a call from the customer to discuss settlement options." Alleda Harrison, a lawyer for Ms. Kolich, said Wells ignored past requests for talks on a settlement. The original purchase of Ms. Kolich's condo was financed by a first and second mortgage in 2004, Ms. Harrison said, and Ms. Kolich refinanced that second mortgage in 2005 to lower the rate but didn't take any cash out.

Meanwhile, the Obama administration is prodding banks to find solutions for more borrowers struggling with junior-lien debts. Under the administration's foreclosure-prevention program, one new U.S. Treasury program requires participating lenders to reduce payments on junior-lien mortgages if they are doing so on first mortgages.

The government also is offering incentive payments for second-lien holders to forgive debts for borrowers who avert foreclosure by selling their homes for less than the debt owed or turning the deed over to the lender. Under that program, the holder of the second lien can be paid, partly by the government, as much as 6% of the outstanding loan balance, up to a maximum of $6,000, but in return must renounce efforts to collect anything more from the borrower.

House Financial Services Committee discusses future of housing finance

2010-04-08T17:11:00.001-04:00

Original posted on Lexology by Sean Whittington:

Yesterday, the House Committee on Financial Services held a hearing on the future of housing finance through Government Sponsored Enterprises (GSEs), including Fannie Mae, Freddie Mac, Ginnie Mae and the Federal Home Loan Banks. The Committee heard testimony from the following witnesses: Panel One:

Timothy F. Geithner, Secretary, U.S. Department of the Treasury

Panel Two:

Sarah Rosen Wartell, Executive Vice President, Center for American Progress
Michael Berman, President and Chief Executive Officer, CWCapital, on behalf of Mortgage Bankers Association
Mark A. Calabria, Ph.D., Director, Financial Regulation Studies, Cato Institute
Vincent O’Donnell, Vice President, Affordable Housing Preservation Initiative, Local Initiatives Support Corporation (LISC)
Robert E. DeWitt, President, Chief Executive Officer, and Vice Chairman, GID Investment Advisers LLC, on behalf of National Multi-Housing Council
Janis Bowdler, Deputy Director, Wealth-Building Policy Project, National Council of La Raza
Anthony Sanders, Distinguished Professor of Real Estate Finance, School of Management, George Mason University
Vince Malta, Vice President and Liaison to Government Affairs, National Association of Realtors (NAR)

In a contentious hearing led by Chairman Barney Frank (D-MA), Republican members continuously pushed Treasury Secretary Geithner for a plan on how to end government control of Fannie Mae and Freddie Mac and account for the costs of their conservatorship in the budget, Ranking Member Spencer Bachus (R-AL) stated near the start of the hearing that "it's unacceptable … that the Treasury Department does not have a plan for Fannie and Freddie." Rep. Bill Posey (R-FL) was particularly forceful in demanding a plan from the administration, stating "We can’t wait forever to find out." While Secretary Geithner conceded that it was not feasible for the federal government to retain control of Freddie and Fannie indefinitely, he also cautioned that moving too quickly could undermine the economic recovery. "There are a lot of challenges ahead … [and we have to be] very careful that we're still helping to facilitate this process of recovery while we transition." He explained that "as we move forward, it is critical we facilitate a smooth transition to any new system. And I want to be clear: Treasury remains committed to supporting the continued activities of the GSEs in conservatorship."

With respect to GSE reform, Secretary Geithner acknowledged that "the form of the housing finance system will change," but maintained that "government has a key role to play in shaping the future of the nation’s housing finance system and in setting housing policy goals." He said that any "new system must be designed to ensure that markets are more stable, consumers are protected, sustainable credit is widely accessible and important housing policies, such as affordable housing for low and moderate income families, are administered effectively and efficiently." Mr. Geithner continued by asserting that "Government has a key role to play in that new system, but its role, and the role of the GSEs in particular, will be fundamentally different from the role played in the past." Among other items, "private gains can no longer be supported by the umbrella of public protection, capital standards must be higher and excessive risk-taking must be appropriately restrained." Geithner promised that the administration would begin formulating a plan to address Fannie Mae and Freddie Mac. He also announced that Treasury and the Department of Housing and Urban Development will submit a list of questions for public comment by April 15 related to the reform of the housing finance system and housing policy.

The second panel, consisting of housing experts, generally supported some form of continued government support for the housing industry. Ms. Wartell echoed Secretary Geithner's call for a measured approach to reform, stating "The current situation, in which the federal government, through FHA, Ginnie Mae or the GSEs, backstops almost 90 percent of the market for home mortgages, is not desirable or sustainable. No one seeks to preserve the government’s expanded role one moment longer than necessary. But there could yet be severe consequences from acting too precipitously to disrupt the unfortunate status quo."

Mr. Berman argued for an explicit government guarantee on mortgage-backed securities funded through risk-based fees. He argued that "the government’s guarantee should be at the security-level, not the enterprise-level. The existing system extended an implied federal backing to all the activities of Fannie Mae and Freddie Mac, including not only their mortgage guarantees, but also their portfolio investments, derivative counterparties and corporate bondholders." According to Mr. Berman, "While we believe it is essential for a portion of the market to have a government guarantee to retain liquidity, it is also essential that private capital be at risk to ensure that lending is efficient, effective and responsive to market conditions."

Mr. Calambria advocated breaking up Fannie and Freddie into "about a dozen" different entities, applying current Securities Act and Securities Exchange Act requirements to securities issued by GSEs, barring foreign central banks from holding GSE debt in order to prevent foreign policy factors from clouding economic policy, and requiring regulators to treat banks' GSE holdings as non-governmental corporate debt. Mr. Calambria noted "While Fannie and Freddie were rescued for a variety of reasons, prominent among those is that fact that their securities, both equity and debt, permeate our financial system. … The financial crisis resulted from the fact that so much of the soundness of our financial system is build upon the sand of house prices."

Mr. O'Donnell argued for incorporating community concerns, noting "A loan that does not work for consumers and communities ultimately will not work for lenders and investors, or for the financial system and the economy." He proposed two guiding principles for reform: "(1) the housing finance system should be integrated in several dimensions, and (2) private institutions that receive public benefits should also help to address public objectives." Ms. Bowdler argued that the private market will not serve low income, minority, elderly or immigrant borrows and therefore it is necessary that the federal government fill this gap. Mr. Dewitt argued for a more balanced policy that "doesn’t measure success solely by how much homeownership there is" and that offers renting as an attractive alternative. He noted "Apartments help create stronger and healthier communities by offering enough housing for the workers that businesses need, by reducing the cost of providing public services like water, sewer and roads and by creating vibrant live/work/play neighborhoods."

Mr. Sanders recommended reducing the GSEs' role in housing by "1) removing their affordability housing mission, 2) unwinding the retained portfolios at an accelerated pace and 3) toughening the regulatory oversight of Fannie and Freddie by moving it to a stronger FHFA." In addition, Mr. Sanders advocated requiring 10-20% down payments. When pressed on this point by Chairman Frank, Mr. Sanders said Congress should mandate that lending institutions require a 20% down payment, or 10% for FHA programs. Mr. Sanders also recommended passing legislation for a covered bonds market which could "potentially provide an excellent vehicle to fund the residential and commercial mortgage markets going forward." Mr. Malta agreed, noting "One tool that has captured the attention of NAR's members is covered bonds. Though an underutilized tool in our current secondary mortgage market arsenal, covered bonds are a product that should be further explored because of the added security these financial vehicles offer to potential investors." Mr. Malta also recommended that "Fannie Mae and Freddie Mac should be converted into government-chartered, non-shareholder owned authorities that are subject to tighter regulations on product, profitability, and minimal retained portfolio practices in a way that ensures the protection of taxpayer monies."

Citi: The mortgage underwriter’s tale

2010-04-07T18:01:00.000-04:00

Original posted on Reuters by Felix Salmon:

The Financial Crisis Inquiry Commission is holding more hearings this week, and the prepared testimony of Richard Bowen, a former senior mortgage underwriter at Citigroup, is well worth reading.

He explains how between 2005 and 2007 Citi’s underwriting standards simply fell apart, as the securitization professionals in the investment bank would override or ignore Citi’s own underwriters:

In the third quarter of 2006 the Wall Street Chief Risk Officer started changing many of the underwriting decisions from “turn down” to “approve.” This was done either personally or by direction to the underwriters. This artificially increased the approval rate on the sample. This higher approval rate was then used as justification to purchase these pools.

In the sample on one $300+ million Merrill Lynch subprime pool the underwriters turned down 716 mortgages as not meeting Citi policy guidelines. The Wall Street Chief Risk Officer personally changed 260 of these “turn downs” to “approved.” The pool was purchased…

Still another $320 million Merrill Lynch pool was purchased with an approval rate of 72%. Citi policy required a minimum approval rate of 90%.

Bowen also explains the sneaky way in which a pool of mortgages which was 60% bad was reported to the Third Party Origination Committee (“TPO”), which had overall responsibility for managing the selling mortgage company relationships, as being 95% good:

I spent time with the QA management and underwriters to better understand the QA processes. I learned that there were actually two categories of “agree” decision, with only the total of the two agree decisions being reported to TPO committee.

There was the “agree” decision, meaning the Citi underwriter agrees with the selling mortgage company underwriter that the file meets Citi policy criteria.

And there was an “agree contingent” decision, meaning that the Citi underwriter agrees with the original underwriting decision. But the decision is contingent upon receiving documents that are missing from the file, and those documents confirm the conditions underwritten.

An an example, the selling mortgage company underwriter may have approved a mortgage file showing a 45% debt to income ratio, which was within Citi policy criteria for the product. However, the required proof of income documentation confirming the borrower income used in the underwriting decision might be missing from the file. In this instance the Citi underwriter would assign an “agree contingent” decision to the file. The agree decision would be contingent upon receiving the income documentation proving the income utilized in the originating underwriter decision.

The total of the “agree” and “agree contingent” decisions would be reflected as the overall “agree” rate when reported to TPO Committee. This overall agree rate was the only agree rate reported to TPO through June 2006. And it was believed by the underwriters I interviewed that over half of the files had “agree contingent” decisions, meaning over half of the files were missing policy-required documents.

The QA process was very manual and lacked any automated reporting. The manager relied upon manual tally sheets, manually added, to produce the aggregate reporting given to TPO committee.

After significant effort, it was determined that the 5% disagree, 95% agree originally reported to June TPO was incorrect. It should have been 5% disagree, 55% agree contingent, and 40% agree. In other words, 5% were not underwritten to Citi policy and another 55% were missing policy- required documents.

Bowen sent an email to Bob Rubin and other senior Citi executives in November 2007. It had the subject line “URGENT — READ IMMEDIATELY — FINANCIAL ISSUES”, and it explained that Citi had yet to recognize enormous mortgage-related losses. I’m looking forward to the commissioners asking Bowen for some tips on what questions they should put to Rubin tomorrow. That testimony is going to be very interesting indeed.

Second Lien Issues Remain with Mortgage Modification Program: Amherst

2010-04-07T07:39:00.000-04:00

Original posted on the Housing Wire by Diana Golobay:

Although the Home Affordable Foreclosure Alternatives (HAFA) program launched this week, a much longer-anticipated mortgage aid program, the Second Lien Modification Program (2MP) is yet to get off the ground.

Late in March, Citi (C: 4.29 +0.70%) became the fourth big lender to sign up. Bank of America (BAC: 18.49 +1.99%) first signed on in January.

Details of 2MP released recently by the US Treasury Department disappointed first lien investors, in part because the program requires the borrower’s consent, according to analyst commentary from Amherst Securities Group. An automatic enrollment in the second lien program when the trial modification on the first mortgage begins would increase the success rate on both.

“[W]e strongly recommend that the second lien be modified (or placed in a trial modification) automatically, with the borrower simply informed that the modification has occurred,” Amherst analysts wrote in commentary this week. “The second lien modification would become ‘official’ at the same time the first lien modification is made permanent, and incentive payments could begin on that date.”

Laurie Goodman, who heads up the mortgage-backed strategy group at Amherst, noted 2MP will likely take a “decent period of time” to be fully implemented. The second mortgage will be modified later in the Home Affordable Modification (HAMP) than is “optimal” from a public policy perspective, she added.

“From a public policy perspective, ideally the 2MP program would begin the same day the first lien trial begins,” Amherst writes. “Doing so would lower the back-end [debt-to-income] of the borrowers, making a successful modification more likely. But in fact, the 2MP modification will begin much later—as long as 120 days after the servicer is notified. It is not clear to us why such a long time frame is necessary.”

It is also unclear what happens to the second liens when principal is forgiven on the first lien under the new, alternative waterfall, according to the Amherst team. Goodman writes that initial guidance from the Treasury seems to indicate that, if principal is reduced on the first lien, then the second would be reduced by at least the same proportion.

But language urging the “extinguishment” of second liens carries the effect of principal forgiveness, rather than forbearance. And Goodman writes that “it is unlikely” the Treasury has decided whether 2MP will implement proportional or complete forgiveness.

For Consumers, Time to Shop (Until the Mortgage Drops)

2010-04-07T07:38:00.001-04:00

Original posted on the Housing Wire by Paul Jackson:

Here’s a provocative thought: what if ‘extend and pretend’ within our nation’s troubled mortgage markets is actually providing a lift to consumer spending? It’s not as far-fetched as the idea might initially sound, and it might help explain some interesting data we’ve seen as of late — and it also might explain why the statistical recovery we’re seeing now doesn’t really feel like a recovery to most Americans.

And, if I’m right, it also explains why we may very well slip right back into the throes of recession all over again as we head into 2011.

Let’s start with what we know. We’ve got 7.4 million non-current loans in this country, according to data source Lender Processing Services, Inc. (LPS: 36.93 +1.07%) — that’s an awful lot of households still living in a house, without a mortgage or rent payment draining their available disposable income. And the mortgage or rent borne by most households has historically been one of the most significant capital commitments any household makes, relative to other purchases.

In fact, as I’ve shown in previous columns, most Americans behind on their mortgage have gone more than a year without making any payments. The average age of a loan in foreclosure is now 410 days delinquent, after all, according to LPS; and that’s just the average. Many delinquent borrowers are able to stay in their homes for even longer than that.

We know from emerging credit data at Equifax and from other credit bureaus that Americans are now more likely to stop paying their mortgage first relative to other debts, meaning that they will continue to pay their credit cards, auto leases and other financial commitments. And why not? Miss a few payments on the car, and the repo men are there to claim that shiny Lexus within weeks; miss a few credit card payments, and dinner Saturday night is immediately disrupted.

But miss a mortgage payment? The consequences here are now so far off into the future and so vague, and layered under numerous government assistance programs, that any future penalties are tough for a consumer to accurately assess when faced with making a choice on how to best manage their debts. (I’d even argue that for many consumers, given the current environment, it makes logical sense to default on their mortgage first.)

So we’ve got millions upon millions of consumers in the U.S. meeting their shelter needs for free, even if only temporarily; and what’s becoming of any extra disposable income, since no rent or mortgage need be paid? Is this money being saved? Of course not. We’re Americans — we don’t know how to save (and neither does our government, apparently).

Instead, we’re seeing consumer spending head northward, and for five straight months, too. This data has many economists touting a nascent economic recovery, but I think the data instead paints a very sinister picture.

Put simply: people are spending their mortgages.

Consider the following individual as a case study — an actual ‘HAMPlicant’ at one of the nation’s larger servicing shops, as highlighted in a guest post at the Calculated Risk blog. They had an $1,880 monthly payment on their mortgage they’d defaulted on, yet their bank statements for the past 30 days included the following expenses:

visits to the tanning salon
visits to the nail spa
some kind of gourmet produce market
various liquor stores
A DirecTV bill that involved some serious premium programming or pay-per-view events
Over $1,700 in retail purchases, including: Best Buy, Baby Gap, Brookstone, Old Navy, Bed, Bath & Beyond, Home Depot, Macy’s, Pac Sun, Urban Behavior, Sears, Staples, and Footlocker

Here’s one household that’s clearly doing their part to ensure that consumer spending stays strong. And any sane person should be asking themselves: How many more people like this are out there among the 7.4 million delinquent loans we now have? And how many more ’spenders’ are there among the 5 million or so currently underwater homeowners — many of whom may at some point decide to default on their mortgage, too, but dutifully continue spending at Best Buy and eating at the Cheesecake Factory?

And the zinger: what happens when these people eventually find themselves, at some point in the future, saddled with rent or a mortgage payment?

Even if you assume that just half of the current 7.4 million currently delinquent mortgages fit this sort of ’spending profile’ (that is, they are spending their mortgage) and you assume a $1,000 median monthly mortgage payment for most U.S. homeowners — you get a $3.7 billion boost per month to consumer spending. It’s certainly enough spending to matter in the overall scheme of things.

A colleague I respect immensely, John Mauldin, has as of late been hammering a simple economic identity we all should be familiar with:

GDP = C (consumer and business consumption) + I (investments) + G (government spending) + E (net exports)

Regardless of how you see it, the dominant variable in the GDP equation above is consumer spending (C); it’s roughly 70% of GDP historically, including health care costs (half of which are actually a government expenditure, but let’s stay out of the minutiae of how data is reported for now). Which means, in the end, that as consumer spending goes, GDP generally goes.

Mauldin sees the risk of recession in 2011 as a 50-50 proposition, largely due to concerns over government stimulus spending and taxation (G). He argues that we must get our deficits under control. But if I’m correct in asserting that there is a ‘delinquency effect’ embedded in our current personal consumption figures, as well, we have even more troubling cause for concern — because shrinking government deficits while simultaneously watching consumer spending tank all over again is a recipe for significant economic pain.

The alternative — government spending its way into oblivion, and headlong into a sovereign debt crisis — isn’t exactly a rosy picture, either. My advice? Plan accordingly, whether for your business or your household.

BlackRock warns on banks’ distressed mortgages

2010-04-06T07:27:00.001-04:00

Posted in the FT by Aline van Duyn:

BlackRock, a leading US bond investor, says banks will have to take their share of losses on distressed mortgages before it resumes large-scale purchases of new “private-label” mortgage bonds, which are sold without government backing.

The position taken by Curtis Arledge, chief investment officer for fixed income at BlackRock, who oversees $580bn of investments, marks the latest development in an ongoing tussle over who should bear the costs of the US mortgage meltdown.

The return of private investors to the US mortgage market, now mostly financed through government-backed agencies, could have a big effect on mortgage rates and the speed of the housing recovery. Efforts to restore confidence among investors have so far failed.

Disputes between investors and banks have erupted over riskier second mortgages, also called home equity loans. Many US homeowners who are behind on their payments took out two or more home loans. First mortgages were typically packaged into securities and sold to investors, while second mortgages were often kept by banks.

These “second-lien” mortgages should take losses first, in theory. But the holders of such debts have not always agreed to absorb hits before “first-lien” mortgage holders. US government programmes to restructure such debts have been slowed by these complications.

Mr Arledge told the FT BlackRock, which is primarily a first-lien investor, had focused on the interaction with second-lien holders in the US mortgage modification programmes. “If [modifications] are done in such a way that is not fair . . . it will be a real challenge for the mortgage market to move forward.”

Banks owning the second-lien mortgages also own many of the mortgage servicers that decide how losses are shared.

“In many cases the person owning the second lien is also servicing the mortgage and running the [modification] process,” Mr Arledge said. “There’s potential for conflicts of interest.”

The Permanent Mortgage Crisis

2010-04-01T17:26:00.001-04:00

Original posted in the Wall Street Journal:

Last Friday the White House announced its latest plan to prevent mortgage foreclosures, and earlier this week the famous Case-Shiller index found mostly flat home prices in January with analysts warning about a new wave of foreclosures to come. You can't blame the latest proposal for that outcome, but what about the previous 10 or 20 federal housing rescue plans?

We're supposed to believe that this latest effort to build an artificial floor under home prices will perform better than the Hope Now Alliance announced by President Bush in October 2007;

better than the revised Hope Now program announced two months later;
better than Hope for Homeowners, which was passed by Congress and signed by Mr. Bush in 2008;
better than the foreclosure moratoriums promoted by Fannie Mae, Freddie Mac and Representative Barney Frank into early 2009;
better than the $127 billion that taxpayers have thus far poured into Fan and Fred, much of it for foreclosure relief;
better than the Federal Reserve's purchase of $1.25 trillion in mortgage-backed securities;
better than last year's expansion of the 2008 First-Time Home Buyer Tax Credit to up to $8,000;
better than the billions in stimulus dollars that have been spent "to restore neighborhoods hardest hit by concentrated foreclosures," according to the White House;
better than the $1.5 billion announced earlier this year to state housing finance agencies in the electorally hard-hit areas of Arizona, California, Florida, Michigan and Nevada, and $600 million more this week for other states certified as political disaster areas;
and certainly better than Mr. Obama's year-old Home Affordable Modification Program to offer mortgage modifications to troubled borrowers or his companion program to offer generous refinancing. We could go on, but you get the joke, even if the housing market hasn't.

Here's a heretical thought: What if Washington had simply let housing prices fall on their own to find their natural bottom? The pain would have been more severe more quickly for some owners who bought more expensive homes than they could afford. But the pain might also be over by now as housing markets cleared faster, and housing might be contributing to a healthier economic expansion.

Instead we are heading toward year five of the housing recession, with Washington proposing even more ideas to prolong the agony. One senior banking regulator we talk to calls it "extending and pretending."

But how long can troubled borrowers even pretend? The latest Mortgage Metrics report from the Comptroller of the Currency shows that most of the loans modified in the first quarter of 2009 had gone bad again within nine months—52% were more than 60 days delinquent.

The highlights of the latest plan are increased incentives for banks to reduce mortgage principal for troubled borrowers, reduced mortgage payments for unemployed borrowers, more regulatory barriers for banks wishing to foreclose, and a new ability of underwater borrowers to refinance into taxpayer-backed loans from the Federal Housing Administration.

Watching its previous failures, Team Obama will now emphasize reducing principal instead of merely lowering monthly mortgage payments for some years. The White House no doubt noticed that many of the loans modified outside of the various government programs—with aggressive principal reductions—had better re-default rates.

But this doesn't mean that such reductions are always a good idea. Many of these private reductions were the result of legal settlements, not business decisions. Obviously if taxpayers chip in to provide equity to millions of underwater borrowers, the borrowers will have less incentive to default. But how many more borrowers will be motivated to seek assistance when the subsidies become more generous?

A lower mortgage bill is surely a relief to an unemployed worker, but what he really needs is a job, and we see nothing in this plan (or any other Washington scheme) to encourage job creation. To the extent that these payments are merely unemployment benefits laundered through the mortgage system and thus reduce incentives to find work, the jobless rate will stay higher for longer and the entire economy will be worse off.

Potentially the most expensive part of this plan for taxpayers is the new Federal Housing Administration refinancing option. (Yes, that is the same FHA that is already struggling under mortgage losses and announced last year that its capital had fallen below the level required by law.) Taxpayers will be required to stand behind a "homeowner" who owes mortgage debt equal to 115% of the value of the home and whose monthly mortgage bill is up to 31% of total income. Message to owners who borrowed responsibly: Next time, don't be such a sap.

You'll also be pleased to know the Administration says the price tag on this latest housing plan won't exceed the $50 billion already earmarked for mortgage relief in the Troubled Asset Relief Program. Just don't expect it to end the mortgage crisis.

Answers to Questions About New Mortgage Modification Program

2010-03-30T22:40:00.001-04:00

The federal government announced new initiatives on Friday to help people who are having trouble paying their mortgages. Here are some questions and answers about the efforts posted in the New York Times Ron Lieber and Jennifer Saranow Schultz.

Q. I am currently unemployed. What sort of mortgage payment reduction can I qualify for?

A. The company servicing your mortgage will be required to offer at least three, and up to six, months of reduced payments. During that time, you won’t have to pay more than 31 percent of your monthly income toward the mortgage.

You have to live in the home to qualify, and the mortgage balance has to be less than $729,750, with a monthly payment that represents more than 31 percent of the gross monthly income of all borrowers who signed your mortgage, before you subtract anything for taxes or deductions. If one person in the household works and one is unemployed, you will not be eligible if the loan payment is under 31 percent of your current total household income.

Also, you need to prove that you are receiving unemployment benefits and ask for help within 90 days of any late payments.

The lowered payments would revert to the regular amounts once you got a job, if you became employed before the three- to six-month period ended.

Q. I’m underwater, since my mortgage is for more than my home is worth. What sort of help might I get from my mortgage company?

A. The company that controls your mortgage might reduce your principal, something that wasn’t happening much before. The government is offering additional incentives for companies to do so.

Your property will need to be worth at least 15 percent less than the value of your first mortgage for you to qualify. If your mortgage has already been modified to lower your interest and monthly payments, you may still be eligible.

To qualify, you need to live in your home, have a mortgage under $729,750 and have a mortgage payment more than 31 percent of your gross monthly income.

Any principal forgiveness will take place in three equal amounts over the course of three years but only if you make your mortgage payments on time.

But banks are not required to participate.

Q. What about the new refinancing option with another lender for people who are underwater?

A. If you’re current on your payments with your existing mortgage provider, you may be able to refinance into a loan through the federal government’s Federal Housing Administration program and have some of your principal forgiven. Here, too, you will need to be occupying your home to qualify; you can’t be an investor or landlord. You will have to document your income to apply.

Your current mortgage holder is not required to write down any principal, but if it does decide to participate, it will have to agree to write down at least 10 percent of the value of your first mortgage. And your current loan cannot itself be an F.H.A. mortgage.

Also, your payment under any new F.H.A. loan must be less than 31 percent of your gross monthly income, and your total household debt can’t be more than about 50 percent of your income unless you have an excellent credit history.

Q. Who decides how much my home is worth and how?

A. There will be a reappraisal, which raises an odd scenario. Normally, when selling your home, you want the appraisal to be at a high value. Here, however, the lower the value of your home the more likely you are to be underwater enough to qualify for help.

Q. What if there is a second mortgage on my home?

A. There are now additional incentives in place to write down amounts on second mortgages to help people become eligible for the F.H.A. refinancings. You may be eligible for help with a second mortgage even if you’ve already qualified for help with a first mortgage.

Q. Is there someplace I can go to get more details?

A. More information is available on the Treasury Department’s Web site.

Q. How will a loan modification affect my credit score?

A. A loan modification may not affect your credit score — at least in the near future.

If your mortgage holder writes down some of your principal, there’s a chance that won’t be a black mark on your credit report, but the exact impact is still unclear.

As of November, the credit reports of borrowers who had been participating in earlier mortgage modification program weren’t necessarily affected just by virtue of their participation. That’s because the Treasury Department and the Consumer Data Industry Association, which represents credit reporting agencies, created a new code for loans modified under a federal government plan. They recommended that lenders use the code but did not require it. In the near term, FICO is ignoring that code in its credit scoring formula.

It’s possible, however, that banks will treat some or all of the new principal forgiveness programs in a different way that could harm participants’ credit reports. A spokesman for the Consumer Data Industry Association said he was still working out what code or codes ought to apply. The federal agencies involved do not tell lenders how to report participation in the programs.

Meanwhile, if you participate in the temporary payment reduction program for unemployed people, you will probably see some damage to your credit report.

Q. When should I call my mortgage servicer?

A. For unemployed borrowers, this should all start in the next couple of months. Some servicers may already have a program in place. The other programs may not begin until the fall.

Your lender is supposed to contact people who are eligible for help, but it’s probably best to call in periodically yourself for updates if you think you may be eligible.

Q. Are lenders and servicers really going to be prepared to handle the volume of inquiries?

A. Many people attempting to modify their mortgages so far have been frustrated by long hold times, conflicting information and lost paperwork. These new programs won’t make it any easier for the companies involved. Make sure to write down the names of everyone you speak to about your mortgage and save copies of all paperwork.

Q. I don’t need any help. Am I paying for all of this through my taxes?

A. The money is coming out of existing TARP funds, so there is no new money going toward these initiatives. So far, at least.

Walking away from mortgages harder to do in Maryland

2010-03-30T12:51:00.001-04:00

Original posted in the Baltimore Sun by Eileen Ambrose:

Every day more homeowners are underwater - meaning they owe more on their house than it's worth - and a growing number of them across the country are simply walking away.

They pack up, throw the house keys in the mail to the bank and start over. Sounds like an easy solution to a difficult problem.

"Anything that sounds really easy or guaranteed is not," says Anne Balcer Norton, director of the foreclosure prevention division at St. Ambrose Housing Aid Center in Baltimore.

Indeed, in Maryland and the majority of states, walking away is no guarantee that mortgage debt won't come back to haunt you. These are so-called recourse states, where a lender can pursue you for any shortfall after it sells the house. So if you walk away from a $350,000 mortgage and the lender turns around and sells the house for $250,000, you can still be on the hook for $100,000.

In Maryland, lenders generally can come after you for up to three years after the sale to collect. And that time limit could be as long as 12 years under certain contracts, says Phillip Robinson, executive director of Civil Justice Inc., a nonprofit legal services agency in Baltimore that assists residents statewide.

Housing experts here say they don't see a rash of lenders pursuing unpaid debt by Marylanders who have been foreclosed upon. But that could change once lenders get past more immediate problems of the housing crisis or start to sell unpaid loans to debt collectors who might want to go after that debt. Mortgage insurers, too, might seek to collect on defaulted loans they covered, experts said.

But this doesn't mean Marylanders can't get out from under an onerous mortgage.

As always, the first step whenever you are about to fall behind on payments is to contact the lender or loan servicer to review your options.

Even if a lender agrees to modify the mortgage terms - which doesn't happen often enough - some consumers still can't afford to stay in their houses.

Some homeowners might consider a short sale, in which you and a prospective buyer get the bank to agree to accept less than what's owed.

Make sure you have a lawyer or housing counselor to represent you in talks with the bank or loan servicer, Norton says. These experts can negotiate a deal so you won't be responsible for the unpaid balance.

Call 877-462-7555 to find a housing counselor, who can also refer you to a lawyer for free advice.

Beware, some real estate agents market themselves as short sale experts, but then fail to negotiate with the bank for any forgiveness of debt, says Tony DePastina, a litigation attorney with Civil Justice. Once you get your finances back in order, the lender could come back after you to collect the unpaid debt, he says.

For some, the only way to get out of the mortgage debt is to file for bankruptcy under Chapter 7, Robinson says. The lender won't be able to come after you for debt that's been discharged by the court.

All of these options have other repercussions.

Foreclosures and short sales, for example, are considered loan defaults, and will remain on your credit report for seven years, says Craig Watts, a spokesman for FICO, which created the most widely used credit score.

A Chapter 7 bankruptcy, which erases other debt besides the mortgage, causes even more damage to a credit score and stays on your credit report for 10 years, he says.

And what's on your credit report can affect your employment. Many employers, for example, review applicants' credit reports before hiring.

Maryland lawmakers earlier this year introduced legislation that would prohibit employers, with certain exceptions, from using credit reports to make hiring and firing decisions. That bill died when a House of Delegates committee voted it down on Saturday, after a Senate committee rejected a similar bill.

Another 15 states and Congress are considering similar legislation.

An FRBB Proposal to Help Distressed Homeowners: A Government Payment-Sharing Plan

2010-03-29T22:52:00.001-04:00

This public policy brief presents a proposal, originally posted on the website of the Federal Reserve Bank of Boston in January of this year, designed to help homeowners who are unable to afford mortgage payments on their principal residence because they have suffered a significant income disruption and because the balance owed on their mortgage exceeds the value of their home. These homeowners represent a subset of the population of distressed homeowners, but according to our research they face an elevated risk of default and are unlikely to be helped by current foreclosure-reduction programs. The plan is a government payment-sharing arrangement that works with the homeowner’s existing mortgage and provides a significant reduction in the homeowner’s monthly mortgage payment. The plan does not involve principal reduction. Two options are presented; both are designed to help people with negative equity and a significant income disruption, such as job loss. In one version, the assistance comes in the form of a government loan, which must be repaid when the borrower returns to financial health. The second version features government grants that do not have to be repaid. In either case, the homeowner must provide evidence of negative equity in the home and of job loss or other significant income disruption. The costs of the plan are moderate, and the benefits should help not only the participating homeowners but also the housing industry, the financial markets, and the economy more broadly.

Download paper here: http://www.bos.frb.org/economic/ppb/2009/ppb091.htm

Foreclosure or forgiveness?

2010-03-27T00:50:00.001-04:00

Original posted on FT Alphaville by Tracy Alloway:

Absent a thorough review of HAMP and its goals, the program risks helping few, and for the rest, merely spreading out the foreclosure crisis over the course of several years…

- Neil Barofsky, Sigtarp, Congressional Testimony

Surprised? You shouldn’t be, because as Sigtarp have previously said, this is exactly what the government is aiming for; re-inflating house prices by preventing a wave of foreclosures.

The US government is now looking at altering the centrepiece of its anti-foreclosure plans, the Home Affordable Modification Program. Where the Hamp aims to keep homeowners in their houses mainly by reducing interest payments, the new scheme will be focused on principal forgiveness.

Principal reduction is probably less prone to redefaults, but it’s something which banks have traditionally been very reluctant to offer for a number of reasons.

But Bank of America made a big principal reduction commitment on Wednesday, announcing a programme as part of a settlement with Massachusetts state.

So which is better, foreclosure or forgiveness?

Barry Ritholtz at the Big Picture and Rortybomb’s Mike Konczal, are erring towards the foreclosure side. The argument being that foreclosures generate economic activity and allow people to move into residences they can actually afford. Deleveraging is what the system needs, and all that.

(Significant) questions of moral hazard aside, which would be worse for the banks, mass principal forgiveness or mass foreclosures? Both would involve some losses — but which would be higher?

BofA’s programme, which is aimed only at certain classes of mortgages, will result in a principal decrease of $3bn — with the foregone amount possibly recognised as a loss upfront. That’s no small number given that the Bank’s loan loss reserves on its mortgage book are about $4.6bn.

But look at this chart from Barclays Capital. ‘Real-estate owned’ is what’s known as shadow housing inventory, or the properties owned by banks and mortgage companies:

And this is where the benefit of Hamp, for banks, comes in.

Even as foreclosures have continued to rise, the REO-category has for the most part fallen. As Barclays have previously put it, the time between the borrower going delinquent and the house actually hitting the market has been delayed. That eases pressure on house prices, and on banks’ books as well.

What we’re lacking here is an estimate of how painful a rise in REO-owned properties would be for banks. Would it, in the case of BofA, for instance, be more than the $3bn in principal reduction?

That’s the big question here, and one we’ve found few answers to so far.

Here, for what it’s worth, is what Barclays Capital says:

The U.S. banking industry has $1.5 trillion of residential mortgages on balance sheet and another $0.6 billion of home equity. While principal mods have proven to have lower re-default rates than traditional mods, principal forgiveness or forbearance could result in an increase in net charge-offs. We also worry that this could lead to more moral hazard. Furthermore, to the extent it is spreading out the foreclosure issues, it could take longer for normalized earnings to be achieved (see shadow inventory). Still, in some instances, the cost of foreclosures could exceed the expected reduction in principal.

More on that Hamp-lified moral hazard

2010-03-27T00:49:00.000-04:00

Original posted on FT Alphaville by Tracy Alloway:

The below is a very timely — and thought-provoking — data set, given that things are once again heating up in the realm of US mortgage modification post-Bank of America’s principal reduction plan.

Behold, courtesy of Amherst Securities, the charted moral hazard in US housing:

In words, those are the default transition rates for various types of mortgages divided into owner-occupied and non-owner occupied — things like investment properties, second homes, and the like.

The default transition rate is that at which previously always performing loans (i.e. never more than a single payment behind) go to two payments behind for the first time.

The idea is to show how an environment that’s increasingly geared towards borrowers, viz all those anti-foreclosure programmes, is affecting their behaviour.

It’s something that’s long been suspected (borrowers are rational economic agents who’d be foolish not to take advantage of some of these programmes, right?) but hasn’t really been proven.

By dividing default transition rates into owner-occupied and non-owner occupied you can sort of isolate the effects of all the modification schemes, since most of them don’t apply to investment properties and second homes. For instance Hamp, the centrepiece of the US Treasury’s housing plans and aimed at reducing interest payments for underwater borrowers, is just for owner-occupied houses.

So, here’s what the Amherst analysts, led by Laurie Goodman, says:

There is no question that the current environment is much more “borrower-friendly” than it was a year ago, by which we mean that delinquent borrowers have more options available to delay or avoid foreclosure. For starters, there have been offand- on foreclosure moratoriums at both the state and federal level. Servicers are also now “strongly encouraged” not to move a borrower along in the delinquency/foreclosure pipeline before testing to see if they qualify for a HAMP loan [modification] . . .

Moreover, borrowers could be going delinquent in order to get a modification. For borrowers already 2 payments behind, modification had been semi-automatic. The borrower must qualify for the program on the basis of stated income and must pass the NPV (net present value) test. If a borrower is current, he must do all of the preceding, plus the servicer must be convinced that default is imminent (requires additional documentation, albeit with no clear guidance on what constitutes “imminent”).

Have borrowers been taking advantage of the more borrower-friendly environment? Has the more borrower-friendly system, which allows borrowers to prolong the rent free period they can live in their home, encouraged further delinquencies?

Using that contrast between owner- and non-owner occupied then, Amherst suggests that borrowers are taking advantage of current circumstances; they’re going into default for the first time.

In fact judging from the above chart, the difference between the two transition rates actually appears to be widening. First-time defaults — strategic or otherwise — are on the rise.

Incidentally, the contrast between the two transition rates is even more stark if you throw the timing of the Hamp programme — which began about a year ago — into the mix:

And here’s Amherst’s conclusion:

. . . Borrowers can stay in their home rent free for a much longer period than was previously the case. However, few of these benefits apply to investor properties. Thus, when we look at the difference pre- and post-HAMP in the behavior of owner-occupied borrowers versus that of non-owner occupants—we find a dramatic difference in performance. Owner-occupied borrowers behave far worse than their non-owneroccupied counterparts.

One wonders what the default transition rate would be for a principal reduction scheme.

Studies Show HAMP Promotes Strategic Default on Mortgages

2010-03-27T00:47:00.001-04:00

Original posted on the Housing Wire by Jon Prior:

The current state of the mortgage market is promoting owner-occupants to default, according to research released today, in an indication of the growing moral hazard behind government-led homeowner rescue programs.

When the analytics firm Equifax looked at the November 2008 vintage of mortgages, it found that owner occupants default at a lower rate than investors or borrowers with second homes. But the vintage studied was in the pre-HAMP era of course, and since then, borrowers are now taking advantage of a new market, one that is especially favorable for owner-occupants, according to Amherst Securities.

Non-agency investors trying to navigate through the murky values of mortgage bonds could take note, according to the Equifax report, as owner-occupancy is considered to be a “key determinant” of loan and deal performance. Investors used to rely on such loan-level data, but when mortgage fraud increased during the current housing crisis, the information became unreliable.

Equifax analysts evaluated a specific sample of loans that were outstanding in November 2008. The 12-month default rate for loans identified as a principal residence at origination was 4.5%, compared to 6.5% for investment properties and 5.5% for second homes.

Analysts found that the trend continued for seasoned loans. According to the report, 18% of loans reported as owner-occupied at origination were no longer labeled as such. Those properties defaulted at a rate of 7%. However, the 66% of those loans were owner-occupied and defaulted at a rate of only 3.7%. To Equifax, the remaining 16% of loans had unclear owner-occupancy status but had a 5.3% default rate.

Investors also need to know what properties are eligible for modification. The US Treasury Department launched the Home Affordable Modification Program (HAMP) in March 2009 to provide incentives to servicers for the modification of loans on the verge of foreclosure. Only owner-occupied mortgages are eligible for the program.

According to the research firm Amherst Securities, HAMP changed the economic environment to a friendlier place for owner-occupants. The Treasury today even launched an initiative to reduce the principal of a loan under the program.

The graphs above show owner-occupied borrowers and investors had similar default transition rates until early 2009. But in early 2009 – HAMP launched in March 2009 – behavior for owner-occupied borrowers began to weaken.

“[T]he environment for borrowers who own investor properties has changed much less than for owner-occupied borrowers,” according to the Amherst report. “[T]hey can live in their house rent free during the time it takes to establish if they qualify for a HAMP mod. And if they qualify, they can stay in the program for at least 3 months, even if they do not make a single payment.”

Here's Why Obama's New Mortgage Forgiveness Push Still Isn't Going To Work

2010-03-27T00:43:00.002-04:00

Posted on the Business Insider by Megan McArdle:

The Obama administration has just released the details on yet another "major" push to help homeowners who are underwater on their mortgages--a number now estimated at something like 20% of all homeowners.

The last big pushes yielded little in the way of results. The problem we thought we had a year ago--vulnerable homeowners being rocked by resetting "teaser rates" on their adjustable mortgages--turns out to be much less pressing than we thought. Instead, we an income problem: a lot of homeowners whose income has fallen too far to afford any reasonable payment on their homes. This is actually a particularly tragic subset of a larger problem, which is the market rigidities introduced by underwater mortgages.

Until around 2005 or 2006, home equity actually cushioned other income shocks. If anything bad happened, you could always refinance, or in extremis, sell. Now people who have had income shocks can do neither. People who need to move for career or family reasons are also trapped.

That's why many people have suggested principal writedowns. But this has run into multiple problems.

The ownership structure of mortgage securities makes this very complicated
Banks reasonably fear that if you make it easy to demand a principal reduction, everyone will do it, causing them to lose money on loans that would otherwise have paid off
This moral hazard problem is particularly pressing for second lien holders. Second mortgages became popular, either to tap home equity, or to avoid the need for mortgage insurance on low-downpayment loans. To do principal reductions, second-lien holders usually have to sign off on taking a total loss on the loan--knowing that they are going to encourage more creditors to stiff them in a similar fashion.
In households that have suffered a job loss, there is often not enough money to pay the loan even with a sizeable principal reduction.
The above is also true of the worst mortgages, which were given to people who never had any reasonable hope of repaying even at a more realistic market price.
Servicers have little incentive to do principal writedowns, which are complicated and don't help them.

The old plan to deal with the problem was to offer modest incentives for modifications, which barely dented most of these issues. So now the administration is going to give lenders incentives to temporarily reduce payments for homeowners who are unemployed, and to do principal reductions large enough to let homeowners refinance into FHA loans.

This probably has more chance of working than earlier efforts--and by working, I mean reducing foreclosures. But there are a few things to worry about:

The temporary payment reductions only seem to last 3-6 months. Given the long-term unemployment problems we're now facing, I'm not sure how much this will help--and if it does help, it seems likely to assist only the least needy. In fairness, however, it at least keeps people with a brief job loss from racking up arrearages that send them into an otherwise unnecessary foreclosure.
The easier you make this, the more moral hazard there will be. You may not care, thinking that this is just about transferring money from banks to needy people--but with the aggressive deployment of FHA loans, that ultimately means the taxpayers are going to be on the hook for a lot of marginal mortgages. Given how badly the FHA has already been overstretched by the collapse of the private market, this is worrysome.
The new plan, like the old plan, will probably provide minimal relief for borrowers in the worst-afflicted areas. The FHA will not finance anything that results in more than 115% being owed on the home, while places like Las Vegas and parts of Florida have seen price decreases of 50%.

FHA Mortgage Workout Lacks Incentives and Creates Problems

2010-03-27T00:41:00.000-04:00

Original posted on the Housing Wire by Austin Kilgore:

New plans to push lenders to offer principal forgiveness and originate Federal Housing Administration (FHA)-backed refinance mortgages are leading borrower advocates to argue that the program isn’t enough to entice lenders and servicers to participate. Additionally, industry players are concerned over the potential moral hazard the initiative potentially presents.

The Obama Administration announced the allocation of $14bn in Troubled Asset Relief Program (TARP) funds to incentivize lenders to provide principal reductions and refinance underwater borrowers into FHA-backed mortgages.

Under the terms of the voluntary program, lenders will be required to write down at least 10% of the mortgage principal for borrowers who are current on their payments. The program is open to borrowers whose mortgage isn’t currently insured by the FHA. The principal reduction must bring the new FHA loan to value (LTV) to 97.75% and make the new payments account for 31% of the borrower’s monthly income. The program also offers incentives to lenders who offer borrowers with second lien mortgages similar principal reduction and refinance options. The maximum allowed LTV of the combined loans is 115%.

John Taylor, president and CEO of the National Community Reinvestment Coalition is one such advocate. In a prepared statement, Taylor said there is a discrepancy between government support for large financial institutions and individuals.

“We rush to give banks tax breaks, but we dawdle to help homeowners who through no fault of their own lost their jobs because of the economic crisis or bought defective loans that caused the economic crisis,” Taylor said. “Let’s not be so quick to forget that we bailed out banks, but we’ve nickeled and dimed innocent borrowers. Moral hazard? The moral hazard is allowing borrowers to pay the price for the crimes of Wall Street.”

Lee Howlett, president of mortgage technology and service provider ISGN’s servicing practice, told HousingWire that the principal forgiveness initiative was expected. “We’ve seen sequential progress toward that over the past year and a half,” he said.

But Howlett believes the industry would have been better served had the principal forgiveness incentives been implemented from the start.

“It’s frustrating in the sense that the people that have gone through some kind of modification, now come back and say I want my principal reduced,” he said. “Every time you announce a program six months after the old one, you run that risk of everybody that’s in the midst of a current trial modification to quit.”

Friday’s announcement left many unanswered questions. According to a Treasury Department release, full details will be announced in an upcoming mortgagee letter. In the meantime, some have questioned how the program will interpret a borrower’s current payment status.

Cheryl Lang, president and CEO of Integrated Mortgage Solutions believes the rules will be fairly lenient and the program’s requirements will turn a blind eye in the event a borrower has had a few slip-ups in the fast.

“If they’re allowing FICOs in the 500s, then they will pretty much put up with anything,” Lang said.

That being said, Lang believes the program will serve as an alternative to borrowers considering strategic default and deter borrowers from purposely defaulting to qualify for other workout programs.

Steve Horne, president of specialty servicer Wingspan Portfolio Advisors, said principal forgiveness “absolutely” has a place at the table as a loan resolution strategy and makes more sense than foreclosing at the rate that the industry has been foreclosing, though like many things, he said, the devil is in the details.

“I am a little concerned that the borrowers get the immediate benefit of principal forgiveness without any requirement for future performance,” Horne said. “I’d like to see some more contingent forgiveness.”

Another lingering question what valuation method will be used to determine the LTV of the underwater borrower. While the Making Home Affordable programs rely on broker price opinions (BPOs), Brian Coester, CEO of appraisal management company (AMC) Coester Appraisal Group, said appraisals are the most appropriate valuation method for the FHA refinance program because he believes the reports will most accurately gauge a property’s value, but that could limit the number of borrowers eligible for the program. But, he added, limiting the number of participants is a better alternative than working off inaccurate valuations.

“Ultimately it’s not going to do any good to the lender or the borrower’s community as a whole because working with bad information leads to bad decisions,” Coester said.

HAMP Principal Write-downs and Other Improvements

2010-03-27T00:37:00.001-04:00

Originals posted on Calculated Risk (here and here):

There are a number of changes to HAMP announced today. This includes help for unemployed homeowners and more outreach. David Streitfeld at the NY Times gives an overview: U.S. Plans Big Expansion in Effort to Aid Homeowners.

Here is a fact sheet from Treasury on these changes.

The key changes are principal reductions and larger payments to 2nd liens (including for HAFA short sales). For short sales, the 2nd lien payment has been doubled from 3% of the outstanding balance to 6% - although this is probably still below the typical recovery rate for 2nd liens.

From Treasury on short sales (and deed-in-lieu):

Increase payoffs to subordinate lien holders who agree to release borrowers from debt to facilitate greater use of foreclosure alternatives including short sales or deeds-in-lieu.
The new payoff schedule allows servicers to increase the maximum payoff to subordinate lien holders to 6 percent of the outstanding loan balance and doubles from $1,000 to $2,000 the incentive reimbursement that is available to investors for subordinate lien payoffs, subject to an overall cap of $6,000.

For 1st lien principal reduction, the incentive from the Federal Government (taxpayers) is to pay 15 cents on the dollar for reductions in the unpaid principal balance for LTVs (loan-to-values) between 115% and 140%. For LTVs above 140%, the payment is 10 cents on the dollar, and for reductions below 115%, the payment increases to 21 cents on the dollar.

The Treasury has some examples here for the various changes.

An example of principal reduction (optional):

Click on example for larger image in new window.

So this is 133% LTV. So the taxpayers will pay 15 cents on the dollar to the lender to reduce the principal by $33,000. This is a payment of $4,950 (the lender takes a loss of $28,050). This still leave the borrower with a LTV of 115%.m

To recap... there are four elements to the Making Home Affordable Program Enhancements:

1. Temporary Assistance for Unemployed Homeowners While They Search for Re-Employment

2. Requirement to Consider Alternative Principal Write-down Approach and Increased Principal Write-down Incentives

3. Improvements to Reach More Borrowers with HAMP Modifications

4. Helping Homeowners Move to More Affordable Housing

The focus is on principal writedowns, but possibly the bigger impact will be from the fourth point - the HAFA program (short sales and deed-in-lieu).

The temporary assistance is just that - temporary. Hopefully the homeowner will find a job otherwise most borrowers will be moved on to #4.

4. Helping Homeowners Move to More Affordable Housing
Increase incentives to provide more homeowners with foreclosure alternatives
Increase payoffs to subordinate lien holders who agree to release borrowers from debt to facilitate greater use of foreclosure alternatives including short sales or deeds-in-lieu.
The new payoff schedule allows servicers to increase the maximum payoff to subordinate lien holders to 6 percent of the outstanding loan balance and doubles from $1,000 to $2,000 the incentive reimbursement that is available to investors for subordinate lien payoffs, subject to an overall cap of $6,000.
Increase servicer incentive payments from $1,000 to $1,500 to increase use of foreclosure alternatives and encourage additional outreach to homeowners unable to complete a modification.
Double relocation assistance payment for borrowers successfully completing foreclosure alternative to $3,000
Help homeowners who use a short sale or deed-in-lieu to transition more quickly to housing they can afford.

I think this change will impact the most borrowers (I think principal reduction will be a limited tool). Treasury is doubling the incentive for 2nd lien holders (may still not be enough), and increasing the incentive for servicers and borrowers.

This is the HAFA program that is scheduled to start in early April. This will probably only apply to around 3 million of the 8 million homeowners who are delinquent on their mortgage (initial guess). And probably only about half of those 3 million will receive a modification or use a short sale.

Bank of America Introduces Earned Principal Forgiveness Among Enhancements to Its National Homeownership Retention Program

2010-03-24T16:16:00.000-04:00

CALABASAS, Calif., March 24 /PRNewswire/ -- Bank of America announced it will look first at principal forgiveness – ahead of an interest rate reduction – when modifying certain subprime, Pay-Option and prime two-year hybrid mortgages qualifying for its National Homeownership Retention Program (NHRP). Several enhancements are being made to the program, including the introduction of an earned principal forgiveness approach to modifying mortgages that are severely underwater. The program changes are designed to encourage greater customer participation in the company's aggressive homeownership retention programs, including our continued strong commitment to the federal government's Home Affordable Modification Program (HAMP).

(Logo: http://www.newscom.com/cgi-bin/prnh/20050720/CLW086LOGO-b)

The Commonwealth of Massachusetts worked with Bank of America to develop these additional homeownership retention strategies that help ensure sustainable solutions and is the most recent state to join the NHRP. There are now 44 states and the District of Columbia participating in the NHRP mortgage modification program and related foreclosure relief payment and relocation assistance programs.

Bank of America developed and launched the NHRP in 2008, in cooperation with state attorneys general, to provide assistance to Countrywide borrowers who financed their home with certain subprime and Pay-Option adjustable rate mortgages (ARMs). Bank of America removed these from the Countrywide product line upon acquiring Countrywide in July 2008.

These new components of the agreement apply to certain NHRP-eligible loans that also meet the basic qualifications for the government's Home Affordable Modification Program. They include:

A first look at principal reductions in calculating an affordable payment through an earned principal forgiveness approach to severely underwater loans.
Principal forgiveness through a reduction of negative-amortization on certain Pay-Option ARMs.
Conversion of certain Pay-Option ARMs to fully amortizing loans prior to a recast.
Addition of certain prime two-year hybrid ARMs as eligible for the NHRP mortgage modification programs.
Inclusion of Countrywide mortgages originated on or before January 1, 2009, as eligible for modifications under the terms of the NHRP.
A six-month extension of the term of the NHRP program to December 31, 2012.

"The centerpiece of these enhancements is a program of earned principal forgiveness that addresses severely underwater mortgages with some of the highest rates of delinquency – specifically subprime loans, Pay-Option ARMs and prime two-year hybrid ARMs that are 60 days or more delinquent with a principal balance of 120 percent or more," said Barbara Desoer, president of Bank of America Home Loans.

"At the same time earned principal forgiveness helps homeowners, it also recognizes and addresses the interests of mortgage investors by ensuring that forgiveness is tied to the homeowner's performance, reducing the probability of a future default under the modified terms, and adjusting the total amount to be forgiven in light of any gains in property values that might occur in an economic recovery."

Bank of America expects to be operationally ready to implement the new principal reduction components of NHRP in May. The bank will identify mortgages that may be eligible for these solutions and proactively contact those customers to ascertain their interest in a modification and to request documents necessary to determine actual eligibility.

First Look at Principal Reductions

With implementation of these enhancements, Bank of America will make principal reduction the initial consideration toward reaching the HAMP's target for an affordable payment equal to 31 percent of household income when modifying qualifying subprime, Pay-Option ARM and prime two-year hybrid ARM loans that are also eligible for NHRP. An interest rate reduction and other steps would then be considered, if additional savings are necessary to reach the targeted payment.

"In our experience with Home Affordable Modification Program and National Homeownership Retention Program modifications, Bank of America has found that many homeowners who owe considerably more on their mortgages than their homes are worth are reluctant to accept a solution that addresses only the amount of the payment without an accompanying reduction in the balance due on the loan," Desoer said. "We believe that by first addressing the significant underwater condition of some NHRP-eligible loans, the rates of customer acceptance of HAMP trial modifications and conversions to permanent modifications on those loans will be improved, and the homeowners will be more motivated to make payments, yielding more sustainable modifications."

Earned Principal Forgiveness

Bank of America is taking an innovative "earned principal forgiveness" approach to HAMP modifications of the NHRP-qualifying mortgages that are at least 60 days delinquent with current loan-to-value (LTV) ratios of 120 percent or higher.

An interest-free forbearance of principal that the homeowner can turn into forgiven principal over five years resulting in a maximum 30 percent decrease in the loan principal balance to as low as 100 percent LTV.
In each of the first five years, up to 20 percent of the forborne amount will be forgiven annually for borrowers that remain in good standing on their mortgage payments.
Forgiveness installments for the first three years are set at the 20 percent level.
In the fourth and fifth years, the amount of forgiveness will be dependent upon the updated value of the property, so that the LTV will not be reduced below 100 percent through principal forgiveness.

This solution will be considered when it provides a more positive outcome under the net present value test than under the standard HAMP guidelines.

Innovative Solutions for Customers with Pay-Option ARMs

Bank of America has begun offering two other affordable and sustainable payment solutions on certain Pay-Option ARMs.

If the principal balance on the loan has grown because the borrower selected an option to make payments that did not cover the interest due and this payment difference was added to principal – known as negative amortization – the bank will consider offering a HAMP modification eliminating the negative amortization feature and forgiving all or part of the negative amortization amount to reduce principal to as low as 95 percent LTV.
If a pending recast of a Pay-Option ARM will increase the customer's monthly payments, a preemptive modification that eliminates the negative amortization feature of the mortgage and converts it to a fully amortizing market rate loan may be offered.

Impact of Mortgage Modification Efforts

The bank estimates that it will be able to offer these enhanced principal reduction solutions to about 45,000 customers who qualify for a HAMP modification, for an estimated $3 billion in total reduced principal offered under this NHRP enhancement.

From implementation of the NHRP in December 2008 through December 2009, Bank of America offered an NHRP modification or started an NHRP-eligible trial modification under the HAMP for more than 175,000 homeowners, providing potential aggregate savings of more than $7.2 billion over the full terms of the loans. The original program is ahead of schedule and certain to exceed original expectations of offering up to $8.4 billion in savings.

Through its overall homeownership retention efforts since January 2008, Bank of America has helped more than 760,000 customers with a completed loan modification or HAMP trial modification. That includes more than 500,000 completed modifications through proprietary programs; plus nearly 21,000 completed mortgage modifications and more than 240,000 active trial modifications through the federal government's HAMP program through February.

While Bank of America will reach out proactively to homeowners identified as potentially eligible for these enhancements to the NHRP program, customers with questions about their loans and the new programs may log on to www.bankofamerica.com/homeloanhelp for further information.

BofA to start reducing mortgage principal

2010-03-24T07:28:00.000-04:00

Original posted on Reuters by David Lawder:

Bank of America will on Wednesday announce plans to start forgiving mortgage loan principal for troubled homeowners who owe more than 120 percent of their home's value or are battling ever-expanding "negative amortization" loans.

According to a summary of the program obtained by Reuters, Bank of America pledged to offer an "earned principal forgiveness" of up to 30 percent in two stages. The lender will first offer an interest-free forbearance of principal that the homeowner can turn into forgiven principal annually over five years, provided they stay current on their payments.

The forgiveness can allow a homeowner to bring the loan value back down to 100 percent of the home's value over five years, according to the plan, confirmed by sources close to the matter.

The plan, to begin in May, is among the first by a U.S. mortgage lender that takes a systematic approach to reducing mortgage principal to tackle the thorny issue of preventing foreclosures when home values drop well below the amount owed.

A Bank of America spokesman declined comment.

Announcement of the program in Washington comes as U.S. lawmakers and housing advocates are becoming increasingly vocal about the need for principal writedowns in order to save homes on a large scale. Amid stubbornly high unemployment, homeowners are seen as more likely to simply abandon an unaffordable mortgage when they have no equity or are deep "underwater" on the loan.

The U.S. Treasury's mortgage modification program has largely relied on reducing interest rates, and has been criticized for failing to address a steep and painful reduction in home values.

The announcement also will come two days after two Washington state residents sued Bank of America for allegedly reneging on a promise it made to modify troubled mortgages when it took $25 billion in taxpayer bailout money.

The lawsuit alleged that the lender has "seriously strung out, delayed and otherwised hindered" modifications because it had financial incentives to do so.

NEGATIVE AMORTIZATION LOANS TARGETED

Under the plan, Bank of America also will slash the principal balance on the worst of the high-risk mortgages written during the height of the housing boom, the so-called "payment option" adjustable rate mortgages that had a negative amortization feature that allowed the principal balance to grow.

On such loans that are delinquent and in danger of imminent default, the lender will announce that it will cut principal to as low as a 95 percent of the property's value.

Bank of America lender also will expand its modification program to consider payment reductions on prime hybrid adjustable rate mortgages that have floating interest rates after two years and will extend its National Homeowner Retention Plan by six months until the end of 2012.

The bank expects to be operationally ready to start the earned principal reduction plan in May. It plans to identify mortgages that may be eligible for these programs and proactively contact homeowners to request documents to verify eligibility.

HAMP applicants tanned and juiced

2010-03-23T17:09:00.000-04:00

Original posted on Calculated Risk by Shnaps:

One aspect of the Making Home Affordable loan modification program known as ‘HAMP’ is almost always taken for granted in its wide reporting – that the borrowers in fact need ‘help’. Moreover, it is generally taken for granted that those seeking modification under HAMP simply cannot afford their monthly mortgage payment. It is assumed that they have made great sacrifices, assumed they have already cut back drastically on discretionary expenses, assumed that they have already gone over their monthly budgets with a fine-toothed comb to eliminate all but the most necessary expenditures in an effort to keep their home. So prepare to be shocked – shocked! – as I share with you that I have seen first-hand that this assumption is oftentimes greatly, seriously flawed.

Let me begin with a word to the wise for HAMP applicants: unless you believe Snooki is now in charge of approving HAMP applications, it might be a good idea to cut back a bit on some of the creature comforts to which you have become accustomed at least a month before submitting your HAMP modification application.

Allow me to explain. The guidelines for servicers participating in HAMP stipulate that the borrower must submit a “hardship affidavit”. This, ostensibly, is to serve as their sworn testimony that they have been driven into default due to some particular hardship they encountered, and despite making every possible sacrifice, they can no longer “maintain payment on the mortgage and cover basic living expenses at the same time". (see HAMP Directive)

To demonstrate this, applicants are required to submit recent paystubs and bank statements. The statements are to help further corroborate the income they report (lest they forget to include all of their paystubs) and also to demonstrate that their monthly expenses are as described on their application. Which is to say that they have already ‘cut back to the bone’ and STILL are unable to make ends meet.

So how do these look in practice? The very first ‘HAMPlication’ that your correspondent pulled up recently showed a wanton disregard for minimizing spending. On the contrary, it looked like “cutting back” for this applicant does not involve such Draconian cuts as eliminating:

• visits to the tanning salon
• the nail spa
• some kind of gourmet produce market (have you seen the price of arugula?)
• various liquor stores
• A DirecTV bill that must involve some serious premium programming or pay-per-view events (or both?).
• And over $1,700 in retail purchases, including: Best Buy, Baby Gap, Brookstone, Old Navy, Bed, Bath & Beyond, Home Depot, Macy’s, Pac Sun, Urban Behavior, Sears, Staples, and Footlocker.

And that was just in one month! They were seeking to reduce a $1,880 mortgage payment that had just gotten to be a real cramp to their ability to keep a roof over their heads.

I’d like to say this is the exception, but it’s much closer to the norm. Many people who request HAMP modifications submit bank statements that demonstrate little if any “belt-tightening” going on.

Somehow, we now expect the same people who asked for ‘liar’s loans’ to be truthful on when it comes to ‘hardship affidavits’?

The Case for Ending the Mortgage Deduction

2010-03-23T17:07:00.000-04:00

Original posted in the New York Times by Agnes Crane:

Mortgages should be made less attractive. That’s one lesson of the recent housing bubble and bust. As long as borrowing seems like the easy road to riches, people will do too much of it. But right now in the United States, the tax code encourages many people to take out big mortgages. That’s why it’s a good idea to put the elimination of the tax deductibility of mortgage interest on the political agenda.

American homeowners can for tax purposes deduct interest on mortgages of up to $1 million. It’s a politically popular arrangement, and the lure of paying a bit less to the government has been an incentive to stretch housing budgets up to, or past, the limit. Even extra cash borrowed under home equity loans can share in the tax largess, whether or not the funds go to home improvement.

Take a married couple spending $400,000 on their home, a bit more than twice the $164,700 median price reported by the National Association of Realtors. The mortgage interest deduction, plus the deduction of property tax, is worth well over $20,000 a year, based on a 20 percent down payment, a 6 percent interest rate, and a 1 percent property tax. That’s an alternative to the $11,400 standard deduction the couple would otherwise be entitled to, but at a 28 percent tax rate, it would still reduce their annual taxes by some $3,000.

And the more the couple borrows, the more they save. A $900,000 home could reduce their taxes by nearly $13,000, assuming a 33 percent tax rate on income.

But not everyone benefits from the mortgage interest tax perk. The gross tax deduction for a married couple in a median home, as measured by the real estate agents’ association, would come to a bit more than $9,000, not enough on its own to make it worthwhile to forgo the standard deduction, which is available to every taxpayer.

The high income needed to take advantage of this tax benefit undercuts the claims of supporters that tax deductibility of mortgage interest promotes home ownership, which almost all Americans seem to assume is a good thing. In fact, it is a distortion in favor of those who need the least help.

The tax logic also encourages families to borrow rather than save. When the personal savings rate is a paltry 3 percent and policy makers are wringing their hands about global imbalances, this is the wrong message to send. Moreover, potential investment is skewed toward housing rather than, say, infrastructure, manufacturing and education.

Economists have been pointing out these distortions for years, but for politicians, advocating the elimination of this deduction is seen as suicidal. One problem is that an immediate elimination would probably pull down house prices, the last thing the already weak housing market needs.

The danger comes from the lower purchasing power that higher taxes would bring. For the couple who used to be able to afford a $400,000 home, the maximum purchase price would fall by 11 percent. The $900,000 home would have to drop about 21 percent in value to offset its owners’ higher tax payments. That sounds like an invitation to open another chapter of the financial crisis.

But even such a big change in tax policy could be phased in slowly enough to avoid disaster. Britain removed the tax advantages of home ownership over a period of 12 years. In the 1990s, the mortgage tax relief rate gradually fell from 25 percent to 10 percent before disappearing completely in 2000.

The British experience teaches another lesson besides the feasibility of a fairer approach to housing tax. Mortgage tax relief ended just as a housing bubble began. Far from slumping, the median British house price rose 145 percent from 2000 to the peak in 2007, according to the Halifax bank.

Higher taxes for mortgage borrowers would not prevent excesses in the United States housing market either. They would need to be complemented by careful controls on lending. But it would be a step in a good direction. As policy makers consider how to reshape this troubled sector of the economy — and the need to raise taxes to shrink an enormous deficit — getting rid of a poorly designed tax incentive is good place to start.

Servicers Streamlining Short Sales as HAFA Nears

2010-03-23T17:05:00.000-04:00

Original posted on the Housing Wire by Jon Prior:

With the Home Affordable Foreclosure Alternatives (HAFA) program kicking off in two weeks, servicers are making their final preparations for the oncoming wave of short sale requests. While boosting technology is key to the build-up, getting the right people in place could be more of a priority to handle the load.

The US Treasury Department will launch HAFA on April 5, 2010 to provide incentives to servicers to provide short sales and deeds-in-lieu of foreclosure for borrowers who failed a modification through the Home Affordable Modification Program (HAMP).

GMAC (GJM: 21.00 +1.01%) is considered the leading servicer in the Home Affordable Modification Program by providing active and permanent modifications on 53% of the more than 66,000 eligible loans in its portfolio.

GMAC began its build-up for the HAFA demand a month after HousingWire broke the HAFA story in October. In November 2009, GMAC formed a liquidation advisor unit to proactively contact borrowers who are not eligible for loan modifications to discuss some alternatives such as short sales.

“We don’t currently have a backlog of short sale requests as many servicers do. We typically acknowledge a short sale offer within three days of receipt,” said James Olecki, a spokesperson for GMAC.

GMAC also revamped its technology platform in December, when the company implemented a customized short sale workflow portal to streamline the approval process. The system permits borrowers and real estate agents to electronically submit short sale offers, similar to a platform launched last month by Equator, the largest vendor management platform used by real estate owned (REO) departments across the country.

While GMAC is making strides in its technology department, Sanjeev Dahiwadkar, founder and CEO of IndiSoft, a technology developer specializing in the default services industry, said the right people in place can play a vital role.

“While technology has its critical place in the short sale process, we believe because of the high emotions involved in the decision making process, that there is a still a small portion that is subjective and requires human intervention,” Dahidwadkar said. “It is equally important for technology to provide a transparent and secure communication channel between all participants to help in the decision making process about how much losses to take or what they can live with.”

Scott Gillen, senior vice president of strategic initiatives at Stewart Lending Services, an REO asset management provider, is seeing two different approaches.

“We’re seeing two things, a build up internally just for the review of what’s coming in. What we’re also seeing though is a lot of outreach to vendors such as Stewart to support a lot of the heavy lifting, and when I say that, you’ve got all of the HAMP denials that are theoretically eligible,” he said.

Most of the companies, according to Gillen, are looking for bandwidth support primarily in the solicitation stage and the follow up with the borrower to determine their interest in pursuing a possible short sale or deed-in-lieu.

According to Olecki at GMAC, the servicer acknowledges a short sale request within three days of receiving one, and he has seen a reduction in the overall short sale timeline. A short sale agreement between the borrower and the servicer under HAFA expires after 120 days.

Why Canada Avoided a Mortgage Meltdown

2010-03-19T17:20:00.000-04:00

Original posted on the Wall Street Journal by Alex Pollock:

Suppose we agree that we would like our society to have widespread home ownership and a property-owning citizenry. Does it take government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac with implied taxpayer guarantees, tax advantages for the interest paid on home mortgages, and government pressure for "creative" mortgage lending to achieve this?

The Canadian experience shows that it doesn't.

Canada makes a useful comparison for the U.S. Both countries are rich, advanced, stable, have sophisticated financial systems and pioneer histories, and stretch from Atlantic to Pacific. But Canada has no housing GSEs. Mortgage interest is not tax deductible. It does not have 30-year fixed rate, freely prepayable mortgage loans. Mortgage lending is more conservative and much more creditor-friendly.

Canadian mortgage lenders have full recourse to the mortgage borrower's other assets and income, in addition to having the house as collateral. This means there is little incentive for borrowers to "walk away" from their mortgage. The absence of a tax deduction for mortgage interest probably increases the incentive to pay down debt. Most Canadian mortgage payments are made through automatic debit of the borrower's checking account—a technical but important point. Canadian fixed-rate mortgages typically have prepayment penalties to protect the lender and the interest rate on the loan is fixed for only up to five years.

This relative creditor conservatism has meant that Canada and Canadian banks have so far come through the international financial crisis in much better shape than their U.S. counterparts. Canada didn't avoid the recession, but mortgage delinquencies have so far remained much lower than in the U.S., with the percentage of loans delinquent 90 days or more at approximately one-tenth of the U.S. level.

What about the home ownership rate—the percentage of all households owning their own home? Isn't there a home ownership price to pay for this Canadian credit conservatism? No.

Here's the home ownership rate in Canada: 68%. In the U.S. it's 67%. The U.S. rate peaked at the top of the housing bubble at 69%. In other words, two very different housing finance systems, one much riskier than the other, produced virtually the same home ownership rate.

This must cause us to call into question longstanding U.S. beliefs about the relationship of government-subsidized housing finance to home ownership.

The former savings-and-loan industry justified its special tax and regulatory privileges, including its right to pay more interest on deposits than commercial banks were then allowed to, by appealing to its role in home ownership. Then came the savings and loan collapse of the 1980s.

Fannie Mae and Freddie Mac took over the home ownership mantra. In the vast risk expansion of their arrogant days, with very high rates of profitability made possible by government-granted privileges, they justified these privileges by appealing to home ownership. It was often said by their supporters that the GSE-dominated U.S. housing finance system generated the highest home ownership rates in the world, which was false, and that this system was the "envy of the world," which was also false. Fannie Mae's annual reports regularly featured a house with an American flag flying.

Now it is clear to everyone that Fannie and Freddie, having done so much to help inflate the bubble and having been dragged into insolvency by its deflation, are wards of the government. The taxpayer bailout of these GSEs is likely to cost much more than the bailout of the saving and loans did a generation ago. The U.S. Treasury has unilaterally signed the taxpayers up for unlimited support of these bankrupt purveyors of government-advantaged mortgage finance.

So the widespread previous beliefs about the desirability of having GSEs were wildly mistaken. It ought to be clear by now that an entity can be a private company with market discipline, or it can be a government body with governmental discipline, but it can't be both.

In this context, it is important to recognize that Canada does have a government body to promote housing finance: the Canada Mortgage and Housing Corporation, which is the dominant credit insurer of mortgages in the country. Whether or not you like the idea of such a government financing operation, at least its status is perfectly clear and honest. The Canadian government owns 100% of its stock. Its guaranty from the government is explicit. It provides housing subsidies which are on budget and must be appropriated.

Let's remember that the original sin of making Fannie a GSE in 1968 was to get it off the federal budget so the deficit looked smaller. Canada in this respect looks superior to the U.S. in candor as well as credit performance.

Sign Up For A HAMP Mod And Your Credit Score Drops 100 Points

2010-03-19T17:18:00.000-04:00

Original posted by the Associated Press:

Some homeowners who sign up for the government's mortgage assistance program are getting a nasty surprise: Lower credit scores.

For borrowers who are making their payments on time but are on the verge of default, the Obama administration's loan modification program can reduce their credit score as much as 100 points. That makes it harder to get a loan and can present a problem when applying for a new job.

Housing counselors say it's unfair, especially because the news often comes as a surprise to homeowners.

"Why should people's credit be hurt even worse when they're trying to do the right thing?" said Eileen Anderson, senior vice president at Community Development Corp. of Long Island, a housing counseling group in New York.

And many homeowners are angry that a program designed to help carries such a penalty, said Kathy Conley, a housing counselor with GreenPath Inc., a nonprofit group in Farmington Hills, Mich.

"It's a feeling of being duped," she said.

Still, the impact is far less severe than a foreclosure, where borrowers typically find their credit is in tatters for years. That's due to the cumulative impact of many months of missed payments and the foreclosure itself, which drags down a homeowner's' credit by 150 points or more on a scale of 300 to 850.

To enroll in the Obama administration's $75 billion "Making Home Affordable" program, borrowers enter a trial period in which they make at least three payments. But some are finding out that their credit score takes a dive during this trial phase. It happens once their mortgage company notifies the three big credit bureaus -- Experian, Equifax and TransUnion.

For delinquent borrowers, the damage was done when they fell behind on their loans.

But for homeowners who are having financial troubles but managing to pay their bills, a request for a loan modification is the first sign of difficulty. And that means a sharp drop in the borrower's credit score.

The credit rating industry defends the practice. People who sign up for loan modifications would not be asking for help unless they were having severe money troubles, said Norm Magnuson, spokesman for the Consumer Data Industry Association, a trade group in Washington that represents the credit bureaus.

"The consumer is going into the program because they're in a financial bind," he said. "Other lenders would need to be aware of that."

The Obama administration acknowledges that enrolling in the program can hurt credit scores. But Meg Reilly, a Treasury Department spokeswoman, said that foreclosure "brings far more serious financial consequences for borrowers and their families."

The credit score issue is an unexpected consequence of the program that has been plagued with problems and disappointing results since its launch last year. Only about 170,000 homeowners had completed the process as of February. Hundreds of thousands more are still in limbo.

Jim Owens, 46, of Harrisburg, Ore., was accepted on a trial basis for the Obama plan last year.

He and his family were in bad financial shape. They were barely able to pay the mortgage and utility bills.

The main reason: After being laid off and unemployed for six months, he took a job as maintenance director at a retirement home. But it paid only around $25,000 year, about $10,000 less than his former job in a city public works department.

He and his wife were also struggling with debt, after taking out a second mortgage four years ago to pay off debt and medical bills.

Late last year, he was searching for a used sport-utility vehicle. He got a 30-day approval for $2,000 car loan.

But that time ran out before he found a car, so he had to reapply for the loan. He was shocked to learn that, after signing up for the Obama plan, he was denied.

"I should have been told," that this might happen, Owens said. "Without credit, you can't do a whole lot in life."

A Citi spokesman, Mark Rodgers, said the company follows the Treasury Department's guidelines for reporting to credit bureaus. "We do not determine credit scores," said Rodgers, who declined to comment on Owens' case.

The impact is worse for borrowers who enroll in the Obama program and are then ruled ineligible.

If homeowners do manage to get accepted into the Obama program and have their loans permanently modified, lenders update the credit bureaus. The new status neither hurts nor helps the borrower's credit score. Over time, they can see their score increase.

"The best way to build credit back is to continue to pay bills as agreed, to use credit wisely," said Tom Quinn, vice president of scoring solutions at Fair Issac Corp., which designed the well-known FICO score system. "As time goes on, the score gradually increases."

Supply of Foreclosed Homes on the Rise Again

2010-03-19T08:08:00.001-04:00

Original posted in the Wall Street Journal by James Hagerty:

The supply of foreclosed homes that banks need to sell is rising again, signaling further downward pressure on home prices in some parts of the U.S.

Mortgage analysts at Barclays Capital in New York estimated that banks and mortgage investors held a total of 645,800 foreclosed homes in January, up 4.6% from 617,286 a month earlier.

According to Barclays, the supply peaked at around 845,000 in November 2008 and then declined through 2009.

Even though the number of people behind on mortgage payments kept rising last year, the flow of homes into bank ownership slowed markedly because of time-consuming efforts to figure out which distressed borrowers could qualify for programs that attempt to avert foreclosures by reducing monthly payments. Meanwhile, brisk demand from investors and first-time home buyers helped banks unload many of the homes they held.

Now the supply is rising again because banks are determining that many homeowners don't qualify for loan modifications and are completing more foreclosures. Home sales also have slowed in recent months.

Barclays projects that the supply of foreclosed homes will rise to about 733,000 in April, then begin to decline again gradually. Foreclosed properties now account for roughly a fifth of all homes listed for sale nationally.

The outlook for sales of foreclosed homes depends heavily on whether the economy continues to heal and manages to create enough jobs to boost demand for housing. It also depends on how many distressed borrowers can be rescued from foreclosure through loan modifications. Nearly eight million households, or 15% of those with mortgages, are behind on mortgage payments or in the foreclosure process. Foreclosures are heavily concentrated in a few states, notably Florida, Arizona, Nevada, California and Michigan.

Estimating the number of homes owned by banks and mortgage investors isn't an exact science. Barclays uses foreclosure-related data from mortgage securities packaged by Wall Street and extrapolates from that to estimate the entire market.

John Burns, a real estate consultant in Irvine, Calif., projected that home prices as measured by the S&P/Case-Shiller national index will fall an additional 6% before leveling off later this year.

While he expected many lower-end homes to show price increases this year, he said that would be offset by steep declines on some luxury homes. He assumed mortgage rates would rise to about 6% by year end and job growth would resume in the second half.

Mortgage Penalties: IRD vs 3 Months Interest Payment

2010-03-18T22:04:00.001-04:00

Original posted on RateSupermarket.ca:

We all know mortgage rates are near all time lows and that rates will inevitably go higher. Long term bond yields, which affect fixed mortgage rates, have increased over the past few weeks, so we’d expect fixed rates to increase as well. But that didn’t happen. Many of the big banks are doing a massive market share push right now, and have surprisingly decreased fixed mortgage rates despite bond yields increasing. Variable rates have stayed constant as the Bank of Canada recently re-iterated there conditional commitment to keep them at this level until the summer, although we’ve seen a slight increase in the discounts to prime with a Prime – 0.55% or 1.70% 5 year variable come out last week.

This has resulted in people starting to prepare for the rate increases, and much talk in the media over the past week about mortgage penalties. When you take out a mortgage, it is a contract that comes with a commitment, but like many contracts, there is an out clause if you’d like to terminate the contract early. However, that out clause comes at a price – and this is the penalty fee.

Historically, the penalty fee has been a payment of 3 months worth of interest, but some lenders use the higher of 3 months interest or an IRD or “interest rate differential”. The IRD is based on the difference between your original interest rate and the interest rate that the lender if they were loaning the funds out today. Some banks cheekily use the posted rates to calculate this differential, although that is usually not the actual rate people get for their mortgages.

As different lenders use different penalty calculations, it can be difficult for consumers to know how much the penalty is. As a result, the government announced in the recent budget that as a move towards greater “consumer protection” they would look at standardizing how lenders disclose and calculate prepayment penalties. This is applicable to fixed rate mortgages as variables don’t have IRD penalties.

IRD calculation

Here is an example of how to calculate the IRD:

First, take the principal balance, multiply it by the difference between the previous high interest rate and the newer low interest rate [i.e. if the old higher rate was 5.5%, but now is 3.5% = 2%]

Divide that by 12

Multiply that number by the remaining months on the mortgage term to get the approximate IRD payment owed

IRD vs 3 months interest

If you’re looking at refinancing to break your current mortgage and move to a lower rate then you simply need to:

Calculate the IRD penalty

Determine how much interest would be paid on the current mortgage rate and term

Compare that to the interest that would be paid with the newer rate

If the IRD is less than the savings between the two rates then it could be worth switching.

The refinancing penalties have become such an issue that the Ombudsman for Banking Services and Investments (OBSI) has seen a rapid increase in the number of new cases that have been reported. In the most recent quarter they received 301 complaints, which is almost twice the number received in the same quarter last year and three times as much over 2008.

So if you’re considering refinancing, find your mortgage documents, see what type of penalty you have to incur to break your current mortgage contract, do some quick calculations and then as always speak to a mortgage specialist before making any final decisions, and in this case, to make sure your calculations are correct.

Happy refinancing.

Mortgage Fanatic

Foreclosure's Wake: The Credit Experiences of Individuals Following Foreclosure (FRB)

Strategic Default on First and Second Lien Mortgages During the Financial Crisis

Mortgage Servicing (Adam Levitin and Tara Twomey)

Foreclosure’s Wake: The Credit Experiences of Individuals Following Foreclosure

Your Credit Score Is a Ranking, Not a Score (Cleveland Fed)

Addressing the Impact of the Foreclosure Crisis (FRB Press release)

A Review of Statistical Problems in the Measurement of Mortgage Market Discrimination and Credit Risk

Collateral Risk in Residential Mortgage Defaults

Primers on "Foreclosuregate" (Update 1)

Moratorium for What? (Alan White on Credit Slips)

An Analysis of Government Guarantees and the Functioning of Asset-Backed Securities Markets

A Third of Public Says It’s Sometimes OK for Homeowners to Stop Making Mortgage Payments

Underwater Solution: Value Gap Refinance - HSH.com

Where Does the Mortgage Market Go from Here?

Canada’s Very Own Mortgage Mess: The Laws and Programs Behind a National Dilemma

Redefault Rates on Loan Modifications Improving Says State Foreclosure Prevention Working Group

FHFA Releases First Conservator’s Report on the Enterprises’ Financial Condition

A Private Lender Cooperative Model for Residential Mortgage Finance

Obesity and Mortgage Delinquencies

Strategic defaults remain high, but relief may be in sight

U.S. GAO: Further Actions Needed to Fully and Equitably Implement Foreclosure Mitigation Programs

Recommendations for Executive Action

Fed: The Depth of Negative Equity and Mortgage Default Decisions

Fannie Mae Increases Penalties for Borrowers Who Walk Away

Are foreclosures racist?

Lenders go after money lost in foreclosures

Ax may fall on tax break for mortgages

More Consumers Making Payments on Their Credit Cards Before Their Mortgages

Subprime Mortgage Default

BofA Begins Principal Reduction on Delinquent, Underwater Mortgages

Should We Dump the Home Mortgage Interest Deduction?

Finra probing mortgage-debt offerings

Take This House and Shove It: The Emotional Drivers of Strategic Default

Experian Provides New Level of Transparency for Non-Agency MBSs

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Geithner vows crackdown on mortgage servicers

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‘Strategic’ Mortgage Defaults Jump to 12% of Total

Moody’s Assigns Redwood RMBS Triple-A as S&P Warns on Credit Risk

Recourse and Non-Recourse Mortgages: Foreclosure, Bankruptcy, Policy

Philly Fed: What "Triggers" Mortgage Default?

Force Banks to Cut Mortgage Principal: Watchdog

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