The earlier post I put up was based on media reports. Now, the Obama administration has officially released its plan to reduce foreclosures. The details can be found here (PDF link). Let’s get into the major components …
The centerpiece of the program is designed to encourage loan modifications through government subsidies and payments — payments that go to mortgage servicers, borrowers, and investors. Here are the details:
- A Shared Effort to Reduce Monthly Payments: For a sample household with payments adding up to 43 percent of his monthly income, the lender would first be responsible for bringing down interest rates so that the borrower’s monthly mortgage payment is no more than 38 percent of his or her income.
Next, the initiative would match further reductions in interest payments dollar-for-dollar with the lender to bring that ratio down to 31 percent. If that borrower had a $220,000 mortgage, that could mean a reduction in monthly payments by over $400. That lower interest rate must be kept in place for five years, after which it could gradually be stepped up to the conforming loan rate in place at the time of the modification. Lenders will also be able to bring down monthly payments by reducing the principal owed on the mortgage, with Treasury sharing in the costs.
- “Pay for Success” Incentives to Servicers: Servicers will receive an up-front fee of $1,000 for each eligible modification meeting guidelines established under this initiative. They will also receive “pay for success” fees – awarded monthly as long as the borrower stays current on the loan – of up to $1,000 each year for three years.
- Incentives to Help Borrowers Stay Current: To provide an extra incentive for borrowers to keep paying on time, the initiative will provide a monthly balance reduction payment that goes straight towards reducing the principal balance of the mortgage loan. As long as a borrower stays current on his or her loan, he or she can get up to $1,000 each year for five years.
- Reaching Borrowers Early: To keep lenders focused on reaching borrowers who are trying their best to stay current on their mortgages, an incentive payment of $500 will be paid to servicers, and an incentive payment of $1,500 will be paid to mortgage holders, if they modify at-risk loans before the borrower falls behind.
- Home Price Decline Reserve Payments: To encourage lenders to modify more mortgages and enable more families to keep their homes, the Administration — together with the FDIC — has developed an innovative partial guarantee initiative. The insurance fund – to be created by the Treasury Department at a size of up to $10 billion – will be designed to discourage lenders from opting to foreclose on mortgages that could be viable now out of fear that home prices will fall even further later on.
Holders of mortgages modified under the program would be provided with an additional insurance payment on each modified loan, linked to declines in the home price index. These payments could be set aside as reserves, providing a partial guarantee in the event that home price declines – and therefore losses in cases of default – are higher than expected.
All told, it appears the government could end up paying as much as $10,500 to borrowers, lenders, and servicers in fees and subsidies per loan, as well as the undetermined cost of subsidizing the interest rate and/or covering the cost of reducing principal.
* The modification plan will not be accessible by speculators. In other words, it’s targeted at owner-occupants vs. investors. It will only apply to mortgages under the conforming loan limit — meaning no “jumbos.” It appears the current conforming loan limits, rather than the limits in place when the borrower took out the loan, will be used to determine eligibility. The current Fannie Mae and Freddie Mac conforming loan limit is $417,000 nationally, and up to $729,750 in areas designated “high cost.”
* Borrowers will potentially qualify for a modification if they have elevated mortgage debt to income ratios (38% or greater) OR they are underwater on their loans (including any first and second mortgage debt). They do not have to be currently delinquent on their payments.
* Anyone who is tagged for the program — and who has a total debt-to-income ratio of 55% or higher (meaning, if you add their mortgage payments to payments on credit cards, auto loans, and so on, it consumes more than 55% of gross income) — will be required to attend a debt counseling program in order to get a mod. Loan modifications will not be allowed to cut a borrower’s interest rate to less than 2%.
A sheet with various examples of how this would work can be found here (PDF link).
Fannie Mae and Freddie Mac will also see some changes as part of this program. Here is what is happening there …
* The Treasury Department will double the amount of money it has committed to inject into Fannie Mae and Freddie Mac (via the purchase of preferred shares) — to as much as $400 billion from $200 billion. The two GSEs will also be allowed to increase the size of their retained loan portfolios to $900 billion from $850 billion currently. The government had previously said the agencies would be allowed to modestly increase their portfolios through the end of this year, then reduce them by 10% a year starting in 2010 in order to reduce systemic risk.
Moreover, borrowers who are upside down — owing more than their houses are worth — may be able to refinance going forward. How?
* Fannie and Freddie will be allowed to refinance mortgages they hold — or that they put into MBS — as long as the new loans (including any refi fees) don’t amount to more than 105% of the current value of the underlying homes.
* Borrowers can participate in this program if they have a second mortgage, but only if the second mortgage lender agrees to stay in second position. The refi loans will feature fixed rates with terms of 15 or 30 years, with no prepayment or balloon payments. Applications won’t be accepted until March 4, when details of the program are released.
What about the potential impact of these two programs? Here is the administration’s take on that …
* The administration says this plan will help 7 million to 9 million families either restructure their loans or refinance them. The breakdown suggests 4 million to 5 million homeowners will be able to refinance, while 3 million to 4 million will be helped by the modification program. The administration says the plan will prevent house prices from declining an additional $6,000 (above and beyond the declines they’re already are suffering due to the economy).
The government is also going to try to make loan modifications more uniform across the mortgage industry. More details follow …
*All banks receiving Financial Stability Plan (meaning, TARP) aid from here on out will be forced to implement a uniform loan modification program. This program will likely follow the blueprint of the FDIC’s “Mod in a Box” program, as well as current modification programs being pursued by Fannie and Freddie. The government will seek to apply any modification program to FHA and VA loans, in additional to conventional loans owned or guaranteed by the GSEs. Details of the guidelines will be released before March 4.
What about the very important question many of us has raised: Will borrowers see their principal balances cut?
* That’s permitted under the plan, but not the focus of the administration’s effort. Borrowers will more likely see term extensions and interest rate cuts.
* Meanwhile, the Obama administration will back legislative efforts to allow bankruptcy judges to cram down mortgage balances. Specifically, the administration prefers that any legislation allow judges to treat any mortgage amount due above and beyond the current value of the borrower’s home to be split out and considered unsecured debt. A payment plan for that unsecured amount can be worked out, just like you’d see with other unsecured debts.
* Finally, the Hope for Homeowners plan will be modified, with the FHA cutting fees that borrowers have to pay and loosening standards so that borrowers with higher debt burdens can qualify, among other things.
UPDATE: So now we have the details of Obama’s plan. The big question is, Will this latest plan work? What are the pitfalls? Well, I have to say I like a few principles that are included here.
First, the mortgage lender/investor appears required to take the “first hit” on whatever modification would get the borrower’s payment down to a 38% DTI ratio. Then the government shares the cost for the next seven percentage points.
Second, the program is targeted at buyers who aren’t yet delinquent on their loans, but may end up in that category. This eliminates the whole “My lender won’t talk to me until I miss three payments” problem.
Third, borrowers will receive up to $5,000 in principal reduction payments from the government over time. The idea is to help incentivize borrowers who are upside down to stay put during the period they are upside down, but paying at the reduced rate.
So what are the flaws? Well, this only applies to owner occupied homes with loans under the conforming loan limit. Some 40% of existing homes sold during the peak of the bubble — 2005 — were purchased as second homes or investment properties, according to the National Association of Realtors. Jumbo loan delinquencies are also rising quickly. Any foreclosures there would not be mitigated by this plan. That’s understandable from a political standpoint (officials don’t want to be seen bailout out the speculators or the rich). But it also limits the plan’s impact.
Another troubling aspect of this plan is the provision that would allow Fannie Mae and Freddie Mac to refinance borrowers into new loans with LTVs of up to 105%. Waiting and hoping for a home price rebound — and refusing to just go ahead and foreclose on loans where borrowers have fallen behind and are upside down — has proven to be a losing strategy. It’s akin to kicking the can down the road, and it has resulted in billions and billions of dollars in industry losses.
Now, rather than cut their losses short, Fannie and Freddie will be allowed to refinance these outstanding mortgages into new lower-rate loans that feature LTVs of 100% or more. A portion of the new loans will effectively be unsecured as a result. That exposes Fannie and Freddie to potentially larger losses down the road if home prices don’t rebound and/or if borrowers just end up defaulting anyway. That, in turn, could result in some additional risk being priced into the GSEs‘ cost of funds.
Bottom line: Taxpayers could ultimately get soaked here if home prices don’t rise in the coming few years. Those losses would come on top of any possible losses stemming from the recent surge in FHA loan volume. FHA, unlike most private lenders these days, still writes loans at LTVs as high as 97%, a significant risk in an environment of falling home prices and rising unemployment.
Furthermore, the plan still doesn’t attack the principal reduction issue head on. Lenders and servicers may voluntarily apply any government aid toward principal reductions. But it appears term extensions and rate reductions will be the main technique used to reduce payments to the 38% and 31% thresholds. The Obama administration is hoping that the threat of bankruptcy cramdowns will inspire lenders to act. But that remains to be seen.
Moreover, in many hard-hit markets (the same ones where foreclosure rates are the highest, including Florida and California), the home price declines are extremely severe. A $5,000 principal reduction incentive payment, spread out over five years, likely won’t be enough to incentive those borrowers to stick around should hardship strike.
And even if they do, what happens when these borrowers want to move? It took several years for borrowers in regional markets like New England and California to get back to breakeven during previous busts, assuming they purchased at or near the market peaks. With foreclosure and/or a principal write-down, the debt they can’t pay back or that exceeds the value of their current home gets wiped away. They are then free to rent for a while and buy a new home later.
Under this plan, it doesn’t look like the debt they owe in excess of their current home’s value will typically be wiped away. That means they’re going to have to come up with large amounts of money when they eventually want to move. That would be covered if home prices rise substantially. But again, we’re talking about borrowers who are deeply underwater — and who will likely remain so for years. More than likely, many of these borrowers will stay put, depressing home sales activity in hard hit markets going forward.
Last but not least, there is the whole moral hazard argument. The government could end up subsidizing mortgage borrowers, lenders, and servicers to the tune of more than $10,000 as part of this program. How is that fair to borrowers who played by the rules … who didn’t buy too much house … and continue to pay their loans on time? Why are they left out in the cold? That’s what many Americans are going to be asking, and what many politicians are going to be hearing from callers.
I would also like to point out, in closing, that market forces ARE working. Foreclosures are actually resulting in overpriced homes burdened with too much debt being moved into the hands of new buyers, who are paying drastically reduced prices. They can therefore purchase using a traditional mortgage. In markets where prices have fallen the most, home sales are currently rising smartly. Delaying and dragging out the downturn by artificially propping up home prices will arguably work against the market healing, even if it makes us all feel good for doing “something.”
Related posts:
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{ 19 comments… read them below or add one }
What a joke! So the taxpayers need to help people who couldn’t afford their home in the first place?? WTF.
How do you think people are going to feel that haven’t had a mortgage in over 20 years?
What will I get because I did the right thing and paid off my home?
I know. ZIP
I agree with your comments. I live in Arizona (a native), and I knew the real estate bubble the past five years was not real, so when I moved up to Scottsdale four years ago from Tucson, I did not buy. I told everyone it wasn’t real. The wages did not support the home prices (not rocket science). I owned very modest homes in Tucson, homes I knew I could afford even if I lost my job. I have been renting for four years now, waiting for the prices to come down, and have been socking away my money and living frugally, like I have have most of my 51 years. During the bubble, realtors in Arizona (and I’m sure other places) were talking about people who bought $400,000 homes with $30,000/year salaries, but they lied on their mortgage applications to buy homes they couldn’t afford. In addition, in 2005, every other car in Phoenix was a Hummer. Houses were appreciating by the second, and the minute these irresponsible borrowers got some equity in their overvalued homes, they took it out and bought expensive cars, plasma TVs, and other stuff they don’t need (and shouldn’t have). I refuse to continue paying taxes to subsidize irresponsible people. What about renters who have done the right thing and have paid their bills? What about people who have already paid off their mortgages? Can anyone say Moral Hazard? Government needs to stay out of the markets.
Whatever the stated bail-out objectives e.g. “save the poor homeowner”, the actual objectives are (stlll/again) largely to help the banks and security owners (Wall St.). The correct perspective is that if a bank mortgages 90% for a home, the “homeowner” is the bank! The individual is a “minority owner”. If a 90% loan is made on a $400K house and the value drops to, say, $250K, the minority owner is out $40K if he walks away, but the majority owner, the bank or subsequent security owner, is technically out $110K, assuming the house can be foreclosed and resold at market i.e. $250K. If (more likely) the home is resold at 80% of market ($200K), the bank/security owner loses $160K.
Thus, keeping the minority owner “on the hook” (debt) for the bulk of his initial obligation supplies the greatest benefit to the bank/security owner. If the government really wanted to help the minority owner, it would call for the mortgage owner to “mark to market” and reduce te mortgage face value to $250K, keeping the minority owners $40K as the (now 20%) down payment and refinance at that level, cutting the minority owners payments about in half.
Ross
Major Issue: can we, as a society and nation, afford to “push the reset button” on our whole economy? That’s what would happen if we allowed all real estate to be devalued by a wave of foreclosures that would cover the whole nation.
OK, so it doesn’t help everyone. What possibly could? More to the point, who’d want to? Speculative and investment values SHOULD NOT be saved, it’s risk capital, that’s NOT THE SAME as principal homes. We need to save our communities, maintain the social fabric of the nation, and bring job creation back to our economy.
It’s not that “politicians want to appear to be doing something”. Look at the facts - we’ve just elected them, with a brief to use central, state and local governmental powers to remedy the financial mess that neocon “free market” deregulations had put in place. They’re doing the thing they’ve been employed to do, and crafting it very well.
This is a good plan. The wise man will support it, invest for it, and work with his community to find positive opportunities in this new landscape. I hope you can be amongst them.
HI all
I used to be a realtor in Pinehurst NC, given that this is a “Golf community “( read wealthy retiree’s).we aren’t as affected , but we too have seen the market plunge with the “service workers” that I know don’t earn but 30 to 35K per annum, buying homes at 175 to 250.K ! That is outragious! I knew Something had to happen ,and it did.
Even the the retiree’s that moved here form cold states just a few years ago now are having trouble paying their mortgage ( brokerage / dividend accounts are way down ).
Now of course with Obama’s “plan” to just save the people that will make the same mistake again, is so mystifying to me and I am now angry as wel , because I too was frugal and bought a modest place that I could afford.”Thanks a LOT” Obama, for again rewarding the very folks that screw everybody else, just like the bankers, maybe we too should all stop paying and “get in trouble/ and therefore rewarded for bad behaviour” and also be bailled out ? HMMMMMM………
Andrea
Hi Mike:
When I read your newsletter about the mortgage bailout plan it occurred to me that the one group that stands to make a lot of money out of this deal are the mortgage service companies. It looks like they will be earning some great fees with no risk on their part. Do you know the name and symbol of any of those firms?
Skip McGrath
HI Mike,
As usual you did a great observation of this new program.
However I been looking any word in regards of Line of credit, which many people been using for various purposes. And even if primary mortgage in a good standing there is a second loans to the house which takes or will eventually take a bite. Are there any plans for this?
another factor which might reduce the impact of this scheme is complexity. If one accepts that root causes of the last four years’ bubble include a lack of inquisitiveness then might this legislation fox a tranche of possible benficiaries?
Greetings,
You talk about the ‘market healing itself’, but the market isn’t the point, unfortunately.
I’d agree completely that we just need to bite the bullet, and let our economy get thoroughly shredded by an uncontrollable wave of foreclosures that would depress housing prices by huge percentages unseen yet…if it weren’t for the human factor.
Sure, a market reset might be the ‘right’ thing for the market. But it’s not the right thing for millions of people, who make up that market. If all you think about is the real estate market, like some abstract notion, then it might seem to be the right choice. The government can’t (and shouldn’t) have that ivory tower a view of this situation, it needs to act to protect the people.
It’s not going to be perfect. Accept that. Your ‘wave of foreclosures’ will still happen in the investment and jumbo markets, and it will burn a lot of people who thought that real estate was infallible, and they won’t get back into it. Some people will find loopholes, and do really bad things, and that’ll be trumpeted to the moon by a slavering press and Republicans who want this to fail. But the vast majority of people who take advantage of this won’t be scamming it. They will have their lives made a little more secure, will be able to free up a little more money to spend each month (thus improving our economy), and will feel a little more confident going forward (improving our economy even more).
The more people the government can do that for, right now, the better, and the quicker this disaster will turn around.
Doing something is the right choice, and I like what I hear in this plan. It’s HARD medicine for all sides, including those of us who can’t take advantage of it. I probably won’t be able to take advantage of any of it, despite paying my FHA 30 yr. mortgage on time for the last 4 months while I’ve been unemployed.
Still, this is not about some abstract market that needs to self-correct.
This is about the human cost of a wave of primary-residence foreclosures. If a government doesn’t intervene to prevent wide-spread disaster on its citizens, that government doesn’t deserve to exist.
– Morgan
Excuse me if this sounds cynical because it could be interpreted that way. Rather, I want to express my views which seem to be accurate AND promote the thinking that we have to read between the lines of what our political and financial leaders are really up to. They’re not telling us the whole story but only what they think we want to hear to make it sound good to us, the citizens. And, they don’t want us to think with critical analysis but hope we just follow them like blind sheep. There are other forces at work that are, first and foremost, motivating them to do what they’re doing for the good of these forces, before the good of American citizens.
I’m specifically writing to wake us up to the latest “foreclosure stability plan” (another in a series of bailouts). It is presented as if it’s purely for the good of the American people, to help them out during these tough times. But look more closely and you will see that a more major motivating factor is to keep money pouring into the pockets of the mortgage loan servicers, the banks and the investors of the mortgage backed securities (MBS). If Americans default on their mortgages and lose their homes, yes, this is a serious misfortune. But the real tragedy they want to prevent, and are presenting in the guise that this is for our own good, is the losses that will accumulate and spread widely throughout the mortgage and investment banking firms.
I’m not suggesting this second, real motivation is bad in and of itself. It has credence in that we don’t want our financial institutions to break down on a wide scale since that will have far-reaching ramifications for our economy and, as a domino effect, for us. Where it raises the question of being “bad,” however, is that the plan is really, first and foremost, a means to keep the money flowing into the loan servicers, banks, investment banks, etc. These institutions are insidiously the power center of America and the world. They are taking more and more of our power and liberties away on purpose. They, the ruling elite who are executing a plan called a New World Order, have ulterior motives of taking over the entire country (and the world).
They call all the shots but present this secretly through manipulative stories and rose-colored glasses via our political magicians who make things look as if they are for the good of the American people. Our political leaders are puppets to the ruling elite bankers and financially powerful. They really don’t have the power they would like you to believe. They will cowtail to their bosses in a heartbeat in order to cover their asses, keep their supposedly powerful facades in tact and keep their financial income streams and benefits flowing for their personal gain.
In essence, what I’m suggesting is just be aware of all of their motives and ask yourself: hmmm, why aren’t they telling us the whole story? Are they hiding something for a particular reason? Or are they taking advantage of the average American’s ignorance, that they wouldn’t understand the deeper underworkings of the mortgage industry? And ultimately, with all the decisions and announcements they are coming out with these days, without consulting with us to see if we agree or would vote in favor of it or not, what are the long-term ramifications of what is being dictated to us?
To DavidL: That’s exactly what the economy is trying to do — push the reset button. Let the markets do their own healing. We cannot as a nation afford to pay for people who can’t manage their money. If you make a mistake, you need to learn from it. A house should not be an entitlement. You need to take out student loans, get a good job, and save for a house. If you can’t afford a house, that’s what apartments are for, so rent. We all have rented at one time of another. We also can’t afford to try to put a bottom on housing prices. That’s partially what got us into this mess to begin with. The markets are telling us that house prices (at least in Arizona) were way too overvalued. The only way someone could get into a house with overinflated prices during the bubble required the use of creative mortgaging. If you have this kind of government interference, forget trying to figure out any market, because there won’t be any private markets left.
Hello Mike,
Over the past few months I have enjoyed reading your insiteful views of our markets especially in the real estate sector. For the most part I really enjoyed your explainatioin of Obama’s mortgage bail out plan but I have to take issue with this comment of yours: “But foreclosures are the market’s way of moving overpriced homes saddled with too much debt into the hands of new, more stable owners. These new buyers can pay drastically-reduced prices, which allow them to buy with traditional 30-year fixed-rate loans instead of all the Frankenstein Financing that was popular between 2004 and 2007″.
I am a 52 years old San Diego businessman. My wife and I have a family of 7. In May of 2007 my wife and I saved enough money through our jobs and the sale of our condominium we owned for 10 years to purchase a home in the San Diego area. We purchased our home with a convensional loan with 35%. Within 8 months of purchasing our home, my wife had lost her job and my real estate development project died abruptly due to the collapse of the US housing market. Unable to find a new job due to the difficult job market we have been forced to live off our savings and put our home on the market this past June. The only offer we have received during this period was for 30% less then we paid only a year and a half ago.
The bottom line is that we did play by the rules and we got screwed by Wall Street and our government that decided to play games with our lives. Why should someone else be allowed to come along and steal my home and my hard earned wealth.
Today’s financial debacle is more about deregulation and lowered mortgage standards during the 90’s to accommodate unqualified buyers with low to no money down. This was followed by the passing of the Commodities Futures Modernization act of 2000 by our US Government through the efforts of Wall Street lobbyists. These factors gave Wall Street the opportunity to create Mortgage Backed Securities and Credit Default Swaps (“financial weapons of mass distraction”) that ultimately gave rise to the real estate bubble. This perfect financial storm has led to the near collapse of the US housing market, and our financial institutions; resulting in the redistribution of American’s wealth to Wall Street banks, Hedge-fund managers, and other institutional investors that have been the only beneficiaries of US bail out money. It seems to me that the average American family is the only one left holding the empty bag.
I’ll be damed if I am going to let Wall Street and our Government steal my hard earned money through foreclosure and selling our home to someone that hasnt paid the price like I did Where is the fairness in that. What about some accountability for Wall Street and our Government? Why arent you talking more about this crime instead?
Agree with your comments. The one remark I would add is that this “helping homeowners” is really about helping banks. Putting a floor on housing values helps banks. Not devaluing any further in any way the existing mortgage backed securities in circulation helps banks. To do what Mr. Larson wants would add further stress to mortgage backed securities in circulation and therefore several bank balance sheets. Depending on your viewpoint (and there are valid perspectives on both sides) it may or may not be advisable
Hold-up here a sec – I’m terribly confused? Hasn’t the government already been put on the hook for these toxic assets? Are not most of the SIVs that have been rolled off the books the same mortgages that the Fed is now throwing money at? Thjis sounds like a lot of smoke and mirrors to me! The only winners in this are the servicers @ $1,500 plus another $1,000 for 3 years equals $4,5000 a pop! Let’s see 9 million homes times $4,500 puts about $40B in the hands of corporations instead of the tax payer???? Who’s really getting helped here?
I’ve owned two homes in two different states. Tiresome as it was, I read both contracts before I signed. Today I rent in Las Vegas. According Obama’s plan I get to pay because people bought more than they could afford (because they lied about their income and the greedy lender didn’t verify). Granted, there were cases where people just didn’t understand, but in my opinion it’s stupid to sign something you do not understand.
I know the lenders were pushing hard to provide mortgages to Wallstreet so they could bundle them into MBSs and put them together, slice em and dice em to make CDOs sell over seas (or to funds) all make billions, but it all started with people buying what they couldn’t pay for.
Most of us get screwed!
I can’t help but feel like there is something more systematic going on all around us. The big players are not that ignorant in their greed. A leveling of the playing field Nationally and Globally is taking place, and most purchasers have played right into their hands, again, w/out being responsible in their pursuit of their own goals. These will and are becoming the majority, so that the % of us that had realistic goals, with safety nets, will be pulled in to the ” Help me I’m falling ” herds. Then the majority will determine the new rules they have planned. ” I’ll agree to anything, just GIVE me my needs ” global dictatorship dressed in a pretty disguised package. My family lives a wonderfully modest, relatively stress free life, that I feel we’ll be able to continue, because our needs that give us happiness, is way below the average national and global ” status quo “.
Just be realistic,
Lanie
I see disaster ahead for this program of intended assistance to housing over-borrowers. It’s unrealistic but well-intended. One group of co-conspirators in running up the prices on homes is/was the real estate brokers and agents. Why haven’t they been targeted as the co-conspirators that they were and are in this economic disaster? Encouraging any potential borrower to exceed more than 1/4 of their total income for housing payments is criminal, in my estimation. It’s too late now to correct the lending guidelines that caused this current catastrophe but it’s not too late to institute more realistic guidelines for future transactions - if there is a futuristic scenario in all of this debacle.
Its a little late now, being it’s april and we have hind site, but what is a good way to profit from this? What will it do to the financial ETF’s.