For the past several months a major experiment has been underway, one which may well suggest how to substantially reduce foreclosure totals. Already several thousand borrowers have been able to refinance with sensible mortgages and the odds are that more about to follow.
It was last July when the FDIC took over IndyMac, a major West Coast lender. What the FDIC found was that IndyMac was servicing 653,000 first liens and that a massive number of borrowers — more than 60,000 — were delinquent, bankrupt or in the process of foreclosure. Working through the files the FDIC determined that as many as 40,000 might qualify for a loan modification.
To this point the FDIC has mailed more than 23,000 loan modification proposals to borrowers and so far at least 5,000 have accepted new and better loan terms.
“On average,” says Sheila Bair, the FDIC chair, “the modifications have cut each borrower’s monthly payment by more than $380 or 23 percent of their monthly payment on principal and interest.”
The FDIC plans to send out another 7,000 modification offers during the next week, so the number of offers and acceptances should rise significantly.
The results achieved to date at IndyMac are significant in several ways.
First, the FDIC plan has resulted in vastly more modifications than the older and more-hyped FHASecure program. In its first full year of operation, HUD says that the FHASecure program resulted in the refinancing of just 3,794 delinquent conventional borrowers — that’s about 76 per state.
Second, the newly-created Hope for Homeowners program (H4H) only began in October and to date results from H4H have been weak: Just 111 applications for all of October and not one loan approval, according to HUD.
While the FDIC is on to something with its IndyMac loan modification program, the IndyMac experiment plainly is not working for a large number of troubled borrowers.
If the FDIC numbers are correct then as many as 40,000 IndyMac borrowers can be helped. Yet even though more than half have been contacted to this point, roughly 5,000 have sought to refinance to date. This is a huge disconnect, a matter which needs to be further explained by the FDIC. While helping 5,000 borrowers is certainly impressive, especially compared with other federal efforts, why would 35,000 borrowers not grab the lifeline being thrown by the FDIC?
Think about it: If you had the chance to slash your monthly mortgage costs, avoid foreclosure and stay away from a bankruptcy court why would you not take that opportunity?
Under the FDIC plan monthly payments for principal, interest, taxes and insurance — what is known as “PITI” — cannot equal more than 38 percent of gross household income. To get monthly costs that low, the FDIC is using such tools as extended loan lengths (from 30 to 40 years), lower interest rates and the forgiveness unpaid fees and charges.
In other words, if there’s a household with two wage earners who are each paid $45,000 a year, they’re making $7,500 a month before taxes. Thirty-eight percent of that amount can be used for housing costs under the FDIC plan, a total of $2,850. Subtract $100 a month for insurance and $250 a month for property taxes and $2,500 remains.
With 6 percent interest over 30 years our model household can afford a $416,979 mortgage.
The catch is that conventional loan programs would never allow 38 percent of a household’s income to be used for PITI. Instead, the usual allowances would be 28 percent for conventional loans, 31 percent for FHA financing and as much as 41 percent for VA loans. (With the VA there is no monthly insurance premium and 41 percent for housing costs would only be allowed if a borrower had no other monthly debts, an unlikely scenario.)
Housing costs, of course, are usually not the sum total of all monthly expenses. People also face bills for car payments, student loans, auto financing and credit cards.
Lenders regard housing costs as a “front” ratio when figuring loan qualifications. If you take the front ratio and add it to other monthly expenses the total is called the “back” ratio.
The FDIC has not mentioned any back ratio for its IndyMac modification plan and that may be why the program has not gotten more borrower acceptance. Why? Because even if someone can devote 38 percent of their income to home ownership costs they may still be financially underwater by the time they pay other debts.
Conventional loans, for example, usually have qualifying ratios of 28/36 — that means as much as 28 percent of a borrower’s gross income is allowed for mortgage principal, interest, property taxes and insurance PITI). It also means that PITI plus auto debt, credit card payments and other expenses can total as much as 36 percent of the borrower’s gross income.
In a similar way, the qualifying standards are 31/43 for FHA loans and 41/41 for VA financing.
Go back to our model household. If 43 percent is allowed for all expenses and 31 percent is reserved for monthly costs the numbers look like this:
If the household takes in $7,500 a month and 43 percent is allowed for all costs that would be a total of $3,225. Subtract 31 percent for housing costs ($2,325) and $900 remains for other monthly debts. As the FHA program has shown, 31/43 ratios work for many borrowers.
However, if the front ratio grows to 38 percent ($2,850) the situation changes. Now only $375 remains for other monthly costs. For many households 38 percent for housing expenses is not financially possible.
The FDIC’s New Deal
Speaking last week, Bair made a substantial change in her modification program: The housing ratio was dropped from 38 percent to 31 percent — a decline of 7 percentage points and the front ratio used by the FHA.
This new FDIC standard has both pluses and minuses. A lower housing benchmark means lenders may have to make bigger interest concessions or principal write-offs to modify loans — discounts that will not thrill lenders, investors or hedge fund managers.
Alternatively, using 31 percent up front to qualify troubled borrowers may substantially lower the number of homes that go into foreclosure even after loan modifications.
“Today,” says Bair, “only around 4 percent of seriously delinquent loans are being modified each month. While the FDIC’s experience at IndyMac demonstrates that modifications provide a better return than foreclosure in the vast majority of mortgages today, many servicers continue to rely on slower custom modifications that are not focused on long-term affordability.
“Over the next two years, an estimated 4 to 5 million mortgage loans will enter foreclosure if nothing is done,” continued Bair. “We believe that this program has the potential to reduce the number of foreclosures by up to 1.5 million, thereby helping to reduce the overhang of excess vacant homes that is driving down U.S. home prices.”
“The FDIC deserves credit for dealing with the difficult problems at IndyMac and then quickly adjusting its program to get better results,” says Jim Saccacio, chairman and CEO at RealtyTrac.com, the nation’s largest source of foreclosure properties and data.
“There just isn’t going to be a perfect program that both prevents additional foreclosures and at the same stops lender losses,” he continued. “The FDIC is plainly aiming for some sense of balance, helping those who can be helped while holding down lender losses. That’s an approach which will likely find a lot of support across the country.”
Peter G. Miller is the author of the Common-Sense Mortgage and is syndicated in more than 100 newspapers.