Within the world of mortgage debt there’s a concept called forbearance. It pretty much means financial mercy at the option of the lender and now the idea is at the heart of a new proposal by the Mortgage Bankers Association to reduce foreclosures among the unemployed.
To see how forbearance works imagine that Smith doesn’t pay his mortgage but even so Lender Jones elects not to foreclose.
Why doesn’t the lender foreclose? Most likely because Jones thinks Smith can re-start regular payments as soon as he starts a new job, recovers from an illness, gets past a temporary set-back, etc. For the lender, this may well be cheaper — much cheaper in today’s market — then a foreclosure.
The MBA is now proposing a targeted forbearance plan for those “who have suffered a temporary and significant reduction in household income due to involuntary unemployment.” Translation: Borrowers who lose their jobs would get help.
The MBA plan starts with an initial 90-day phase during which borrowers make mortgage payments equal to 31 percent of their household income. However, those who can’t afford even $300 a month would not be required to make any payments during this first phase. The first phase can be renewed twice under the plan, meaning that unemployed homeowners could find as much as nine months of financial relief and some would be able to avoid any monthly mortgage payments for as long as three months.
“For unemployed borrowers the MBA plan has some plain benefits,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com. “Late fees would be prohibited and families could stay in their homes. Foreclosure numbers would be reduced simply because foreclosures would not be allowed while borrowers are in the program. This would also hold down the inventory of unsold lender properties and reduce the pressure on housing prices.”
The question, says Saccacio, “is how much the government and the public are willing to pay for such benefits.”
Borrowers in the MBA program could reduce monthly mortgage payments and in some cases payments would even be suspended during the first phase of the plan. However, regardless of whether payments are made or not made the costs of ownership continue. The property is still being taxed. It must be insured. And loan owners still want to collect both principal and interest.
To offset the ongoing costs of ownership the MBA plan includes several benefits for lenders and servicers.
First, to offset costs, the MBA wants loan servicers to get some help from Uncle Sam. Under the MBA plan, the government would provide “reasonable funds at a fixed rate to participating mortgage servicers to facilitate advances of principal, interest, taxes and insurance for the extended forbearance period.” In other words, what borrowers don’t pay would be offset with taxpayer money.
Second, the MBA is seeking a change in accounting rules. In a letter to Treasury Secretary Tim Geithner, the MBA says lenders need favorable accounting treatment under the plan to make it work. Because payments of some sort are being made lenders want to be sure the loans will not be defined as “collateral dependent” and marked down in value.
This sounds like really dull stuff but what it means is that lenders in the program would not be required to value distressed loans as if they were in default, something that would increase lender capital requirements, cut profits and drop stock values.
Third, lender participation is voluntary, so not every borrower would have access to the program.
Fourth, at the end of the program borrowers might qualify for permanent refinancing under the government’s Making Home Affordable program. However, if that’s not possible, then the MBA says “the servicer could either enter into a repayment plan or modify the mortgage without reduction of interest rate or extension of term.” The catch is that if interest rates are not reduced and the loan term is not extended then the door is left open for modifications which might actually require higher monthly payments (because the remaining loan term is three to nine months shorter and some payments may have not been made).
And if the borrower ultimately can’t get back on track?
Then, says the MBA, there should be a “loss sharing mechanism” so that “a portion of lost value of the home is paid to the investor, similar to the home price decline program.”
If lenders are to receive monthly payments for principal and interest, will they receive 100 percent of what they’re owed or something less? The experience with AIG — where government money was passed through AIG and used to fully pay off insurance contract counter-parties who would have gotten much less in a bankruptcy — is unlikely to be repeated.
If the government is to be involved in loss sharing, does that mean at some point that Uncle Sam — perhaps through Fannie Mae or Freddie Mac — will wind up with a huge portfolio of distressed homes? If yes, are such homes to be acquired on the basis of their current market value, a figure which might be considerably lower than the borrower’s debt?
No less important, will the government go for loss sharing in any form? Right now losses rest entirely with loan investors, meaning that critics will undoubtedly characterize the program as a bailout — a term with potent, and perhaps dire, political implications.
Whether the government will adopt the MBA plan is unclear. How losses and costs will be divided is certain to be debated. But at least the MBA has put forward a loan modification proposal, something that’s new, interesting and perhaps workable once the details are resolved.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.