This post was submitted by ULI Senior Resident Fellow for Housing John McIlwain, who analyzed guidelines issued by the Obama Administration regarding its plan to mitigate home foreclosures nationwide.
Yesterday, the Treasury Department announced it was publishing the guidelines for the Administration’s "Making Home Affordable" program. This is the second half of the "Homeowner Affordability and Stability Plan" announced several weeks ago. The first part is the program requiring Fannie Mae and Freddie Mac to refinance mortgages they hold or have guaranteed even if the principal amount of the loan is more than 80 percent of the value of the home (but not more than 105 percent). This program is also underway now.
The Making Home Affordable program is far more complex than simply asking Fannie and Freddie to refinance a high loan-to-value mortgages. In this part of the plan, lenders have to voluntarily agree to modify a loan. The first step is for the lender to bring the amount of the borrowers’ monthly payments (including principal, interest, insurance and taxes) down to 38 percent of their income by reducing the interest rate (but not below 2 percent). Then the monthly payments are to be reduced further, down to 31 percent of income, and the government will share the cost of this further reduction including, if need be, a reduction of principal.
Because the program is voluntary, there are incentive payments for lenders, servicers, and borrowers. There is also what are called "Home Price Decline Reserve Payments," which will cover part of the decline in the value of a home if a modified loan has to be foreclosed later on. These are designed to encourage lenders to modify loans even if they fear that home values are declining and so it is better to foreclose now than later.
At this point the program gets quite complex. In fact, these complexities are both necessary, given the wide variety of circumstances borrowers may be in, and may be the downfall of the program. Sevicers of single family mortgages work on very thin margins and are already overwhelmed by the volume of defaults, requests for modifications, and foreclosures. They have little capacity to work through all the various provisions included in the guidelines.
Furthermore, there are a number of business and legal reasons why it is far easier for a servicer to opt to foreclose on a loan than attempt to modify it. The history of loan modifications over the past year also has been mixed to say the least; over half of them by some reports are already back in default (though this is most likely due to the fact that only those modifications done by the FDIC in fact reduce the monthly payments to 31 percent of income--the rest have been short term deferrals of part or all of the amounts due but unpaid due to the default). So one question is whether the incentives for the servicers and lenders will be sufficient to encourage modifications in large numbers.
This is by far the most ambitious plan to stem the increasing flood of foreclosures. Nevertheless, it has its limits. An increasing number of the defaults and foreclosures each month are due to borrowers losing their jobs in the declining economy. To put it bluntly, it is hard to calculate 31 percent of no income, and so this plan is unlikely to help the unemployed.
Furthermore, there are some 13 million homes "underwater," with loans worth more than the value of the homes. As home values continue to fall, this number is rising. It is all too possible that these borrowers will at some point chose not to opt for a loan modification but simply send in the keys (called "jingle mail" in the business) and walk away from homes in which they have no equity.
So the Administration get an A for effort and thoughtfulness. There may in fact be no better plan possible short of a moratorium on all foreclosures. Many borrowers will likely get modifications they would otherwise not get, which is all to the good. But this plan is unlikely to end the growing number of foreclosures, only slow it somewhat.
