The FHA has a new plan to reduce foreclosures. The basic idea is to take properties in trouble and sell them off at discount to investors.
The usual pattern has a servicer work with a borrower to see if a loan modification or short sale is possible. If these options fall through it’s off to the auction block and the certainty of a bad result.
One outcome is that the property sells at foreclosure auction but at a price which is insufficient to cover the debt and foreclosure costs. In this case the lender takes a loss.
But if the property does not sell the outcome can be worse. Now the property is added to the lender’s inventory of distressed homes where it likely produces no revenue while costs for insurance, maintenance and taxes pile up. Again the lender is taking a loss.
Under the new program a servicer can add a loan to the FHA’s distressed asset program if the borrower is at least six months delinquent, loss mitigation hasn’t worked, foreclosure proceedings have started and the borrower is not in bankruptcy.
At this point, says HUD, “FHA-insured notes are sold competitively at a market-determined price generally below the outstanding principal balance.”
Translation: Investors can buy loans at a discount, reflecting real world pricing. HUD is writing down principal values under the theory that selling troubled loans is cheaper than increasing its stock of distressed loans.
The government says up to 20,000 distressed loans will be sold to investors each year but the transactions are not simple. “HUD will require that no more than 50 percent of the loans within a purchased pool become real-estate owned (REO) properties and — if the servicer and borrower are unable to bring the loan out of default — that the servicer hold the loan for at least three years.”
The HUD restrictions raise some questions: What if the borrower is not making any payments? Must the investor still keep the loan for three years? How much of a discount is required before investors accept such terms?
Not only is complexity a concern, so are the numbers.
The FHA program has faced more than 150,000 claims so far in fiscal 2012, so why allow only 20,000 loan sales to investors? If FHA claims are a problem — and they are — then why not encourage more investment?
HUD should get credit for trying to bring more investors into the mix. And if the initial efforts are successful then perhaps the program can be enlarged to get more troubled loans off FHA books.
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