The Coming Wave of Stealth Foreclosures

More than 1.4 million borrowers have been offered trial mortgage modifications through the federal government during the past year, a significant number by any standard. What’s also significant is this: The surest place to find future foreclosures is among the very people Uncle Sam is helping.

Delayed Results
While anyone with common sense would like to see fewer foreclosures, the reality is that the numbers are up. In 2009 there were 3,957,643 foreclosure filings according to RealtyTrac, a number that rose 21 percent over 2009. So far in 2010 RealtyTrac says that first-quarter foreclosure filings have increased 16 percent when compared with a year ago.

What’s important about these figures is that they would have been far higher if more than a million borrowers had not entered the no-foreclosure zone, the safety patch created by the government’s Making Home Affordable program. Once enrolled, borrowers cannot be foreclosed as long as they’re in trial programs with reduced monthly costs.

But while the government’s effort is laudable, the unfortunate reality is that it will not provide long-term relief for many borrowers — including a big percentage of the 230,000 who now have “permanent” mortgage modifications.

The problem is this: A typical borrower with a federally modified loan is saving $512 a month — and while $512 a month is a big deal for most households — modified mortgages remain grossly unaffordable.

Affordability
Under the Obama plan, monthly mortgage payments are limited to 31 percent of the borrower’s gross household income — the money earned before taxes. That’s well within the realm of reason under traditional borrower standards.

For instance, with customary lending requirements a borrower wanting a fixed-rate, 30-year mortgage could qualify if no more than 28 percent of his or her monthly income covered basic housing costs — principal, interest, taxes and insurance. The qualifying ratio for the FHA program is 31 percent, 33 percent for adjustable-rate mortgages and as much as 41 percent for VA financing (if the borrower has no other monthly debts).

So far, so good. Here’s what’s not so good. The numbers above for monthly housing costs are called the “front” ratio. There’s also a “back” ratio.

The back ratio includes the front ratio costs mentioned above plus other monthly debts such as auto payments, student loans and credit card payments. The traditional back ratio for conventional mortgages is 36 percent while it’s 43 percent for FHA loans, 41 percent for VA financing and 38 percent for ARMs.

The catch is this: The government reports that a typical borrower with a modified mortgage has seen their back ratio fall from 77.5 percent to 61.3 percent — that’s a 14.4 percent drop. A big drop. A reduction that should be applauded.

Alas, it’s a reduction that’s not enough.

Look at the traditional back ratios. See anything close to 61 percent? Anything close to 50 percent?

Budgets
In a household with a $90,000 annual income there’s a monthly pre-tax income of $7,500. Here’s what happens to such a household under the Obama program:

  • The household will pay $4,598 for housing costs, car loans, student debt and credit card payments.
  • Subtract federal income taxes ($6,669 a year — married, no children, $50,000 in taxable income) and monthly cash availability drops by $556.
  • The household will pay 6.2 percent for Social Security and 1.2 percent for Medicare so they’re out another $555 per month.

Add it up and the borrower’s basic living costs total $5,709. This leaves $1,791 a month for food, state taxes (if any), gas, car insurance, etc.

Can a household with a modified loan make it?

Scrupulous skimpers and savers might succeed with a tight budget and a lot of luck. But what happens if the car needs a repair? What about medical insurance? Utilities? A dental appointment? What if there are children? (For the record, the typical household income in the United States was $52,029 in 2008, the last year for which we have Census figures.)

“There’s no possibility that this family would have gotten a mortgage under traditional lending guidelines,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com. “Not close. A 60-percent back ratio is off the charts. You need both a reasonable front ratio and a sensible back ratio to have financial stability. One without the other is a sure-fire formula for disaster.”

Government figures confirm this view. The Office of the Comptroller of the Currency show that 29.8 percent of the loans modified in the third quarter of 2009 were at least 30 days late. In comparison, the Mortgage Bankers Association says in the third quarter of 2009 that 3.79 percent of all loans were 30 days past due — one-eighth of the rate for modified loans.

“Only some of those modifications will convert to final, five-year status,” says the Congressional Oversight Panel. “Even among borrowers who receive five-year modifications, some will eventually fall behind on their payments and once again face foreclosure.”
 
The government’s loan modification program will unquestionably save some borrowers from foreclosure. At the same time, a lot of modifications should be seen for what they are: Stealth foreclosures, delaying actions and not outright financial cures.
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Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.

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