I am keenly aware that this does not sound like a fun thing, but honestly you really need to look at the latest mortgage modification plan from the Federal Reserve.
Now you may wonder, why would anyone with a functioning brain want to read nine pages of complex and convoluted bureaucratic ramblings? Because — for the first time — the Federal Reserve is moving toward practical and humane foreclosure relief. Not only for homeowners, but also for real estate investors.
This entire process started Jan. 27 with a letter from Federal Reserve Board Chairman Ben Bernanke to Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee.
Remember, the Fed is an independent entity that answers to no one — at least in theory. In practice, the Federal Reserve building is across the street from the Washington Mall, not far from the Lincoln and Vietnam Veterans Memorials. Surely someone inside the Fed must have noticed the two million people who were on the Mall and nearby streets to attend the Obama inauguration on Jan. 20. Within a week, years of uninterrupted obedience and fidelity to the lending community began to show signs of change.
The goal of the new policy, Bernanke said in his letter, “is to avoid preventable foreclosures on residential mortgage assets.”
This sounds great, as have past federal policies to stem foreclosures, but when you look at the details, the limitations and the exceptions you can see that while the new Fed policy is a step forward, it's a short step.
So what is it that the new Homeownership Preservation Policy for Residential Mortgage Assets says and does? What's good and what's bad? Let's take a look.
Policy & Practice
The purpose of the policy, says the Fed, is to “avoid preventable foreclosures” in those cases where the Fed can “maximize the net present value of the assets for the benefit of taxpayers.”
The idea is try to save those who can be saved — and that's not everyone. However, given that the government is now a major investor in more than 200 banks, including the biggest banks in the country, the Fed effort could potentially be the largest foreclosure rescue effort to date, and one with real impact.
The Fed divides home loans into two groups, “whole” residential mortgages and mortgage-backed securities. The “whole” mortgages are portfolio mortgages, loans that lenders actually own. The second group represents loans that have been used to create mortgage-backed securities.
The new Fed policy applies in large measure to whole loans, mortgages that have one owner and that the Fed “holds, owns or controls.” When it comes to mortgage-backed securities, however, the Fed “may hold only a fractional interest along with other investors” and thus has a limited ability — and maybe no ability — to modify loans.
What's not said is that the Fed's “fraction” may actually be substantial and yet — without the agreement of other security owners — the Fed may not have any right to change the terms of loans that support mortgage-backed securities. What's also not said is that securitized mortgages represent millions of loans.
“The distinction between whole mortgages and those sold to create mortgage-backed securities means that a large portion of the mortgage universe is effectively off-limits,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the nation's largest online foreclosure marketplace. “The new Fed policy appears to offer no change to the millions of borrowers with loans that have been sold to investors in the secondary market and packaged to create mortgage-backed securities. The issue of how to modify securitized loans remains both outstanding and unresolved to this point.”
The Fed policy outlines a series of steps to determine which loans can be saved and those which will be foreclosed.
Proactive Review: The Fed says “if residential mortgage assets become subject to this Policy” then the Fed or its agent (meaning the lender, servicer or originator) will take a look to see if “borrowers should be offered a loan modification.”
Plainly a lot of loans will not be subject to the new Fed policy, but you have to start somewhere.
The Fed says its new policy will apply to ‘residential mortgage assets” but it does NOT say that the property must be owner occupied. Instead it says that “in applying this Policy, the Federal Reserve Bank or its agent will give priority to residential properties that are owner-occupied.”
This is hugely important because the need is to reduce the stock of foreclosed properties, inventory which holds down local home prices. Whether a home is owned by a resident or an investor makes no difference if it sits empty on your street.
The Fed policy appears to be the first time that any federal entity has recognized the need to help real estate investors.
60 Days: To qualify for a modification a borrower must be 60 days delinquent. This is a step back from the recently-announced early-workout program from Fannie Mae and Freddie Mac which allows individuals who are NOT delinquent to seek loan modifications.
The practical problem here is that many lenders instantly and automatically begin foreclosure actions once a borrower is 90 days late. The Fed program creates a 30-day window where either a borrower gets help, faces substantial fees which result from foreclosure actions, or they can lose their home outright.
If the Fed does not act affirmatively within a month, if paperwork is lost or held up, homeowners could easily lose their properties.
New Terms: The Fed says that loans can be modified by reducing interest rates, extending loan terms, deferring or reducing principals and “changes to other terms of the loan.”
This is the usual brew of modification remedies, but borrowers will only be able to get help when the loss from foreclosure is expected to be greater than the loss from a modification.
Since it's usually estimated that lender losses range from $40,000 to $80,000 in a typical foreclosure — figures which no doubt have risen in the past 18 months — borrowers have some idea of the Fed's break-even point, the financial tipping point which determines whether they will lose their home or keep it.
Among the new terms that might be offered, fixed-rate financing rather than an ARM, the waiving of outstanding late and delinquency fees, and loan terms that run as long as 40 years. Also, the Fed may offer temporary loan modifications for borrowers with short-term payment difficulties.
Affordability: The Fed says a modification must “result in the borrower having a mortgage debt-to-income ratio of 38 percent or less under the senior mortgage, as determined on a fully amortizing basis and including real estate taxes, hazard and mortgage insurance and, where applicable, mandatory homeowners’ association dues, ground rents, special assessments, and similar charges.”
This is a far-higher housing cost than the 31-percent standard the FDIC is using to modify loans that it controls from the takeover of IndyMac. The Fed standard is also far tougher than the 34-percent benchmark that Countrywide is using to modify some 400,000 mortgages — a standard worked out with a number of state attorney generals. If the Fed's goal is to modify loans to “avoid preventable foreclosures,” then the natural extension of that objective should also be to avoid re-defaults, something more likely with a lower standard for housing costs.
Negative Equity: Last November, Zillow reported that a third of all home sales now involve upside-down owners, those who owe more than the property is worth. This happens because in recent years huge numbers of buyers have bought real estate with little or nothing down, in many cases with loans that allowed negative amortization. The Fed, to its credit, recognizes this problem and says priority should be given to the homeowners in the worst situations, “in any case where such balance is 125 percent or more of the estimated current value of the property.”
Second Loans: Many recent borrowers purchased homes with piggy-back financing — an 80 percent first loan and a second loan for much or all of the balance. The idea was to buy with little or nothing down and avoid the cost of private mortgage insurance. An interesting strategy — if home values go up.
Since rising values have not been common in most markets during the past year or more, many piggyback borrowers are now in deep trouble.
Where the first and second loans are owned by the same investor, the Fed wants to consolidate the mortgages and make the terms more affordable for the borrower. By affordable the Fed means that total housing costs equal to as much as 43 percent of the borrower's gross monthly income will be allowed.
In practice few borrowers will be able to sustain payments equal to 43 percent of their income unless they have no other monthly debts. In a world filled with car loans, credit card debt, student loans and frequent urges to eat, the likelihood of success at the 43 percent level is fairly close to zero.
Where the Fed does not own or control a second or subordinate loan, then all bets are off. The Fed has no authority to force a second lender to modify loan terms. Alternatively, in situations where the Fed holds the second loan but not the first the same issue arises — the Fed cannot force the first lien holder to change loan terms.
One area where the Fed has broken new ground is that it will consider modifications of rental properties with one to four units. This is a substantial departure from past federal modification plans and recognizes the reality that a large number of properties facing foreclosure are rentals.
It's important to modify troubled investment property loans because otherwise such properties will be lost to foreclosure.
Once foreclosed, there is no difference if the empty property down the street that pushes down local home values was owned by the resident or an investor. To buyers the property is still empty, still abandoned and still evidence of the need to pay less.
If there is an investment foreclosure, the Fed says that paying tenants should be allowed to remain at the property. This, also, is important because there is no sense hurting tenants who pay or having a property which is unoccupied and thus subject to vandalism and disrepair.
The Bottom Line
The government has tried a number of efforts to rescue failing borrowers and to date there have been no successes. The hugely promoted FHASecure program resulted in 4,037 delinquent conventional borrowers who were able to refinance with FHA loans. The Hope for Homeowners program has attracted 412 applications between October 1, 2008 and January 15, 2009 — with not one loan approval.
Meanwhile, RealtyTrac.com reports that in 2008 some 3.2 million foreclosure filings — default notices, auction sale notices and bank repossessions — went out to the owners of 2.3 million homes.
The Federal Reserve's new policy is in some ways a step forward, in other ways not so much. Time will tell if the Fed's new policy produces any meaningful impact in the marketplace, the only measure that counts. If not, and if not in short order, expect Congress to set its own standards and benchmarks.
Peter G. Miller is the author of the Common-Sense Mortgage and is syndicated in more than 100 newspapers.