December 2, 2022

Congress Proposes Cram-Downs As New Mortgage Solution

The plight of homeowners delinquent on their mortgages has been the focus of much debate lately.  There have generally been two major lines of thinking:

-The best course is to let free market principles apply.  If homeowners cannot afford the mortgage payment, the old fashioned remedy of foreclose should take place, turning an overburdened homeowner into a renter.

-Those more inclined to assess the loss of a home in terms of human suffering rather than as an economic equation have sought to provide relief to struggling homeowners by modifying the terms of the original mortgage.

As the number of mortgages in default grew, the situation attracted the attention of politicians.  Their viewpoint seemed to focus on helping the homeowner stay in the home, regardless of cost.

The governments’ efforts to encourage the banking industry to cure the foreclosure problem through voluntary participation in loan modifications was a failure.   For a variety of reasons the loan mods were not working.   Data from the Comptroller of the Currency shows that over 50% of modified loans re-defaulted within 6 months.  With many loan mods, payments went up for the borrowers and principal was hardly ever reduced.  The loan mods actually left many borrowers in a worse position than when they started.  In addition, most of them had negative equity before and after the loan mod.  The negative equity position locked them into the house, unable to sell or refinance.

Today, from Washington, a new solution – giving bankruptcy courts the power to alter the terms of the original mortgage.

Lawmakers Set New Mortgage Bankruptcy Bill

WASHINGTON (Reuters) – Legislation designed to stem foreclosures by allowing bankruptcy judges to erase some mortgage debt will be introduced by Congressional Democrats on Tuesday, and hopes are high that it will pass after a similar plan failed last year.

“Economic conditions have only worsened since we last debated this plan,” said Rep. Brad Miller, a member of the House Financial Services Committee who plans to introduce a bankruptcy reform bill on Tuesday. “Until we stop the slide in foreclosures and falling home prices, the economy will get worse still.”

The legislation would change allow bankruptcy judges to modify home loans in the same way that they currently may modify other unsettled obligations, such as credit card debt.

The lending industry has said that allowing bankruptcy judges to modify mortgage obligations would change how they weigh risk. Currently a lender knows that it has recourse to foreclosure if a borrower fails to meet mortgage payments, but the lender does not have to factor in the possibility that the payments it receives could be decreased by a judge.

What will be the impact of allowing bankruptcy judges to discharge (cram-down) mortgage debts?  Some of the issues and questions to be considered include the following.

1.  Interest rates are correlated to risk – that’s the way things work in a free market.   If a mortgage loan is made with the risk of principal impairment by bankruptcy, this risk has to be priced into the loan rate.  Reducing mortgage principal by legislative fiat may bring unintended adverse consequences.

According to The Mortgage Bankers Association “It is our position that if this proposal were to become law, mortgage rates would increase by at least one and a half points. In addition, lenders will be forced to require higher down payments and charge higher costs at closing. All these increased costs would be necessary to account for the new risks that lenders will face when judges decide to change how much borrowers owe on their mortgages.”

2.  Since total mortgage delinquencies are less than 10% and not all of these cases will wind up in bankruptcy,  cram downs might help less than 5% of mortgaged homeowners.   If the MBA is correct and mortgage rates rise significantly due to cram downs, expect a significant backlash from the other 95% of mortgaged homeowners who will wind up paying for the losses through higher interest rates.

3.  According to The Housing Wire, 50% of Americans oppose bailing out troubled homeowners. “These findings indicate that there are significant political barriers to proposals now being drafted in Congress”

The bankruptcy discharge of a mortgage balance will be viewed by many as the ultimate bailout.  The final compromised bill may result in contorted regulations that ultimately benefit few homeowners.

4.  The free market has a solution for “troubled homeowners” which is known as foreclosure.  Does the free market solution lose all merit merely because the number of foreclosures increased dramatically due to imprudent borrowing and lending?

5.  According to Rep. Brad Miller, “Until we stop the slide in foreclosures and falling home prices, the economy will get worse still.”   Rep. Miller is confusing a symptom of the disease as the cause.  Falling home prices did not cause our economy to weaken.    The housing asset bubble that burst was due to reckless lending, fueled by a government providing easy credit and obsessed with making everyone a homeowner. Political interference in economic matters usually delays a solution by impeding the free market forces that will ultimately prevail anyways.

6.  If the mortgage cram down bill is passed, it will drive many homeowners to bankruptcy, lured by the promise of wiping out mortgage debt.   The loan modification program allowed the banks to pretend that the amount they were owed would still be repaid over time.  When the loan gets reduced in bankruptcy, this illusion will be gone.  More write offs by the banks could lead to a self defeating cycle of tighter credit, stricter mortgage underwriting, weaker housing prices and further bailouts.

7.  How many homeowners that are incapable of handling the burden of home ownership will be allowed to remain in their homes, only to face foreclosure again at a later date?

8.  Continued massive government support of the mortgage market will be necessary since investor demand for mortgage securities is likely to remain low due to collapsing housing prices and the risk of mortgage debt being discharged by bankruptcy. How does an investor properly price a mortgage security where the asset value underlying the security is declining and also face the risk that the principal investment may be impaired by court decree?

9.  The Fed is now expected to absorb virtually all of the new mortgage backed securities this year.   With the Fed extending its purchases into virtually every asset class, a question comes to mind.  As the Fed assumes the losses of all failing economic entities in the country, at what point does the US Government begin to share the credit quality of those being bailed out?

Home Ownership Turns Into Nightmare For Many

The government’s obsession with making everyone a homeowner, regardless of qualification, has resulted in misery for millions and trillions in financial losses.  Here’s another example of our failed social experiment.

Housing Push For Hispanics Spawns Wave of Foreclosures-WSJ

California Rep. Joe Baca has long pushed legislation he said would “open the doors to the American Dream” for first-time home buyers in his largely Hispanic district. For many of them, those doors have slammed shut, quickly and painfully.

Mortgage lenders flooded Mr. Baca’s San Bernardino, Calif., district with loans that often didn’t require down payments, solid credit ratings or documentation of employment. Now, many of the Hispanics who became homeowners find themselves mired in the national housing mess. Nearly 9,200 families in his district have lost their homes to foreclosure.

For years, immigrants to the U.S. have viewed buying a home as the ultimate benchmark of success. Between 2000 and 2007, as the Hispanic population increased, Hispanic homeownership grew even faster, increasing by 47%, to 6.1 million from 4.1 million, according to the U.S. Census Bureau. Over that same period, homeownership nationally grew by 8%. In 2005 alone, mortgages to Hispanics jumped by 29%, with expensive nonprime mortgages soaring 169%, according to the Federal Financial Institutions Examination Council.

An examination of that borrowing spree by The Wall Street Journal reveals that it wasn’t simply the mortgage market at work. It was fueled by a campaign by low-income housing groups, Hispanic lawmakers, a congressional Hispanic housing initiative, mortgage lenders and brokers, who all were pushing to increase homeownership among Latinos.

The full article is well worth reading as it details how reckless lending and borrowing by numerous players, some corrupt and others simply stupid, helped to cause the greatest housing crash in history.

The country has now learned the hard way that home ownership is not the best option for many people.   See Long Term Housing Stability Based On Strong Borrowers.

If sound underwriting guidelines had not been abandoned over the past 10 years, the rate of home ownership would have been marginally lower and we never would have had a housing boom or a housing bust.  We would have all been better off without either.

Is A Loan Modification Worth The Cost?

With the large number of people in arrears on their mortgages, various governmental agencies have been attempting to provide solutions.   Loan modifications have been proposed as the answer for over a year now.  The FDIC has recently been pushing this as the solution to keeping people in their homes and  spearheaded the effort to formalize and streamline the mortgage modification procedure.

From a practical standpoint of the person who is behind on their mortgage, the most important questions to ask, assuming that you want to remain a homeowners, are as follows:

  1. Do I qualify to have my mortgage modified?
  2. Will a loan modification help me in the long run?
  3. Should I pay someone to get a loan modification?

1.  As far as qualification goes,  a good place to start is by reviewing the new SMP guidelines – see Streamlined Modification Program – Who is Eligible? If a review of the guidelines leads you to believe that you qualify for a loan modification, a good way to start is by calling your loan servicer directly, whose phone number is on your monthly statement.

Be advised, however, that nothing is simple when it comes to a loan modification.  The process is controlled by different parties with different interests.   If your mortgage is not owned by Fannie Mae or Freddie Mac, the SMP guidelines that they issued may not apply to you.  A large percentage of mortgages originated over the last five years were sold on a worldwide basis to many different investors.  Generally speaking, the loan servicer that you are dealing with is operating under the guidelines of the investors who own your mortgage.  Some of these investors are willing to do a loan mod and some are not.  The terms of a loan mod that each investor allows will differ depending on their guidelines.

2. Whether or not a loan modification will help in the long run is a complex topic and will be the subject of another post.  Each loan situation is unique but if we examine the data from the Comptroller of the Currency, Office of Thrift Supervision, the results of a loan mod after 6 months showed re-default rates of 50 to 60%.

Three Months After Modification (30+ Days Delinquent)

Six Months After Modification (30+ Days Delinquent)

On-book portfolio (loans held by servicers)

35.06%

50.86%

FHLMC (Freddie Mac)

39.09%

57.87%

FNMA (Fannie Mae)

38.34%

57.11%

Private Investors

42.28%

60.76%

3.  Assuming that questions number 1. and 2. were answered with a “yes”,  a potential loan mod applicant should assess whether or not it makes sense to pay someone to do the loan modification for him.  The loan mod business seems to growing larger every day with a large number of companies offering to provide  loan mod services.   Some factors to consider when deciding whether or not to engage a loan mod company to help you include the following.

-How difficult will it be to get my mortgage modified?  The best way to get a preliminary assessment of this is to call your loan servicer, whose number is on your mortgage statement.  Depending on your situation and who owns your loan, it may be relatively simple to provide the servicer with the documents that they are requesting.  Many servicers and investors consider getting your loan current again to be in their best interests so they should be willing to help you out.

-If for whatever reason you do not want to deal with the loan servicer directly a call to a non profit organization such as Hope Now cannot hurt.  I have heard some people say that they have helped, some say that they are a waste of time; either way, a free phone call is an easy way to find out.

-Keep in mind that if you do engage the services of a loan mod company, they do not have any special powers of persuasion over the the investor owning your mortgage.   The loan servicer is going to make the same modified payment offer regardless of who they deal with.

-The price of a loan mod varies depending on what company you engage to help you.  I have seen prices ranging from $700 to $3500.  The amount of fees charged upfront also varies as do the service guarantees.  Some companies want the entire fee upfront and sometimes the entire fee is nonrefundable.

-If a loan mod company has expertise in the mortgage modification business they should be able to give you an accurate idea of what they can accomplish for you.  For example, there are some servicers (due to restrictions by the investor) who essentially refuse to modify a mortgage.  Regardless of who owns your mortgage, the loan mod company should be able to tell you give you a good idea of how your mortgage will be modified and what your new monthly payment will be.

-A principal reduction is done by very few servicers so if the company you are speaking to guarantees that they can do this for you,  be very skeptical.

-Do not work with any loan mod company without first checking their references.  There are few state or federal licensing requirements or proof of expertise required to enter this business so it is “buyer beware”.     Do not pay more than a modest nonrefundable application fee ($300 to $400 is common).  I would also not recommend engaging a loan mod company whose fee is nonrefundable.   You are paying for their expertise and they should know if they can help you before they take your money

-If your mortgage is delinquent by 90 days, which is usually required before a loan can be modified, do you really have up to $3,500 to spend getting your loan modified, when the odds of re-defaulting are up to 60%?

Conclusion:

There are reputable loan mod companies willing and able to get your loan modified for you and save you the time and hassle of paperwork and phone calls.   Considering the cost that most loan mod companies charge, your best bet is to directly contact your loan servicer or a nonprofit help agency first.

HUD Loan Modification Program Called A Failure

None other than the Secretary of Housing and Urban Development has declared the HUD loan modification program, known as Hope for Homeowners, to be a failure.   Steve Preston, HUD Secretary , blamed Congress for the program’s failure.  “What people don’t understand is that this program was designed to the detail by Congress”.

The Hope program,originally expected to help almost half a million people, has had only around 300 applications since its launch.   The chairman of the House Financial Services Committee blamed the Bush administration for opposing features of the bill that would have made it acceptable to lenders and easy to use by homeowners in default on their mortgages.   There have been calls by others on Capital Hill to use a portion of the TARP funds to ease and expand the Hope program.

In theory, the Hope program would have been beneficial to both borrower and lender by turning a defaulted loan into a performing loan.  It was structured to refinance a homeowner into a 30 year fixed rate mortgage insured by the FHA.

In reality, features of the Hope program seemed to have been designed to make it unattractive to both borrower and lender.  Specific provisions that created problems and made the program basically unworkable for all parties were as follows:

  • there was no obligation on the part of lenders to participate
  • the FHA would only insure  a new loan for up to 90% of the homes value.  Cash strapped borrowers had no way of coming up with the cash for the shortfall on what was owed.  For example, a homeowner owing $150k on a house now appraised at $100k could get a new low rate mortgage of $90,000 but only if he could come up with the $60k balance due on the original loan.   Someone with $60,000 available would probably not be in default on the mortgage.   The only other option to bringing $60,000 cash to closing was to request that the lender write down the loan balance to $90,000, which most lenders politely declined to do.
  • in order to qualify for the Hope loan, borrowers had to sign a statement testifying to the fact that all of the information they provided on their original loan application was accurate.  With the large number of stated income loans done in the past, many borrowers could not sign such a statement.
  • fees were to be assessed on any homeowner refinancing under the Hope program, monies that many homeowners did not have.
  • there were also limitations on the allowable debt to income ratio on the new loan in order to qualify.  Many would not have qualified even under the reduced loan amount and lower payment.
  • since the government was sharing with the original lender a portion of the losses on the refinance and loan write down, a portion of any future price appreciation upon sale by the homeowner would be due to the government

The amount of the new loan allowed under the Hope program and insured by the FHA has now been raised to 96.5% in an effort to make a refinance more appealing to the original mortgage lender.

Additional change to the Hope program are expected after the new administration takes over in January.

Signs Of A Bottom In Real Estate

The Federal Reserve would like us to believe that lowering rates will reverse the decline in housing values.   They have brought interest rates to virtually zero  providing some payment relief to selected borrowers.  In the long run, however, efforts to prop up the price of housing with rate cuts and loan modifications will merely prolong the slide in values.   If the Fed had the power to prevent a decline in housing prices, they would have done so.  In a free market economy, prices will eventually reflect the reality of matching home ownership with income.   The Fed can lean against the primary trend but it cannot change it.

The lending distortions of the past that created the bubble in housing are now gone.   It is no longer enough to say that you make $150,000 – you need to prove it.   It is no longer possible to get 100% financing with poor credit.  The poor lending decisions of the past are causing pain for both borrowers, banks and the economy at large.  Lower rates alone will not clear the market.

The free market has solutions to over leverage and poor lending decisions.   The solutions are called write offs, bankruptcy and foreclosure.   As painful as these measures are, they are the mechanism for building a financially strong base of homeowners who will be far less likely to default on their mortgages.

During the height of the housing bubble several years back, only 10% of California households qualified for a conventional 30 year fixed rate mortgage.  The bubble prices were nurtured and sustained by exotic lending programs with no income verification.  Fast food workers bought $1,000,000 homes.  Now the bubble has burst.  The positive side is that prices are reverting to levels where real buyers with real income can now buy and have an affordable and sustainable payment.

Evidence of a healthier housing market is also seen in the National Association of Realtors housing affordability index.  This index shows an all time high of housing affordability based on income.  The Case Schiller data on price to income ratios also shows a marked improvement of affordability although it is still 20% over the long term average prior to 2000.  This is all good news which is being masked by the ongoing  housing bust.

Hints that we are finally arriving at fundamental values in housing can already be seen in San Diego.

Forbes reports that intrepid investors are buying houses out of foreclosure and renting them out at a profit – often to neighbors who lost their own homes.

Randy L. Perkins amassed a nice fortune in real estate, life insurance and investment banking in southern California over the past 30 years. Since May he has sunk $5 million of it into the one place most investors least want to be: housing.

Perkins has bought two dozen homes in the San Diego area through his Westview Financial Group. One was a dilapidated three-bedroom stucco in Escondido for which Westview paid $158,000–a 61% discount from the previous selling price of $408,000.

Westview eventually spent $40,000 on acquisition costs and improvements. Then it rented the home for $1,800 a month, netting about $18,000 in annual profit after property taxes, maintenance and insurance. That’s a 9% return on the acquisition cost before income taxes…

Currently one in every 32 San Diego homes, a total of 34,854 units, is in foreclosure. That ranks it as the 21st-most-troubled housing market in the nation.

Now first-time buyers and investors like Westview are offering a glimmer of hope. In September the number of San Diego homes sold rose 56% from a year earlier to 3,366, according to DataQuick. More than half were bought out of foreclosure, indicating that Perkins is far from alone in seeing promise amid the wreckage.

Priced properly anything will sell.  Time and price will accomplish what the Fed cannot.  There are oceans of private money looking for an adequate return on capital.  Let the free markets do their work – and the pain of the housing bust will soon be solved.

Loan Modification Efforts Continue

Despite the recent news that many of the mortgage loans modified have gone back into default, the loan modification effort continues.  Until a better solution is found loan modification efforts will continue, especially given the full backing by the FDIC and other government leaders.  It is likely, however, that the approach and methods will change to ensure that future loan mod efforts are more successful.

Bank United Announces New Loan Mod Efforts

Bank United announced today that it will intensify its efforts to save troubled homeowners  by outsourcing much of the work involved in a loan modification.   To anyone familiar with the delays and inconsistent procedures being employed by many banks in their loan mod efforts, this new approach is a welcomed fresh approach.  Many loss mitigation departments are overwhelmed with work, causing many months of delays before the homeowner receives any type of loan mod offer.   In many cases, the rules as to which loan is modified and under what terms also seems to be inconsistently applied.

Many of the $1 billion in delinquent loans at Bank United apparently are due to the large number of pay option arm loans that were originated.   Given the large drop in property values and the negative amortization features of the pay option arms, many borrowers in this category  have a large negative equity position.   The most probable course of action that Bank United will take for this category of borrower is to reduce the principal balance.   Without principal reduction, the borrower would still be in a negative equity position which frequently leads to default.  Unless the homeowner is wildly bullish about housing prices, very few people will continue to make payments on a $400,000 mortgage when the house is valued at $200,000.

With Bank United stock selling at 33 cents and almost 10% of their loans in default, they would apparently have little to lose by offering to put their borrowers in a stronger position through principal reduction.  As previously discussed, long term housing stability is based on strong borrowers.

Ocwen Shows High Success Rate With Loan Mods

Ocwen Financial reported that results with their loan modification efforts far exceed the industry results.   Ocwen is experiencing less than a 25% delinquency rate 60 days after the loan mod, compared to the industry average of over 50%.

CEO William Erbey stated that “The salient issue is not the efficacy of loan modification as a loss mitigation tool, but whether mods are being properly designed.   Our loan approach achieves the twin objectives of keeping homeowners in their homes and maximizing the net present value of the mortgages to the investors who own the loans.”

Mr Erbey further stated that “the re-default problem lies with how some servicers are doing modifications, not with concept of modification. It’s possible to do modifications right. It’s challenging, but we’re doing it — and doing it in a way that’s scalable.”

Ocwen’s good results seem to reflect it’s use of high technology applied on an individual basis.  Rather than having a loan mod decision made by an individual, the characteristics of the loan and the borrower are assessed using artificial intelligence technology.

To date, Ocwen appears to be an industry example of the right way to do loan modifications.  This year alone, Ocwen has kept over 60,000 borrowers in their homes with the mortgages now being paid on time.

Long Term Housing Stability Based On Strong Borrowers

When will the housing market improve?  That seems to be the question of the day so I offer some observations.

When you hear that financing is hard to get for a home mortgage, what you are really hearing is that unqualified buyers are not being approved.

If you can verify adequate income, are able to make a down payment of at least 3% and have decent credit (at least a 580 FICO score), getting a mortgage approval at a low rate is not difficult.  You will not be approved for a mortgage if you cannot verify your income, if you have terrible credit or if your income is insufficient to support your mortgage and other debt payments.  This is a healthy change for housing long term since ultimately, weak buyers are not capable of sustained home ownership.

Buyer psychology is an important part of the home buying process.  Just as in the stock market,  where higher price trends will entice more buyers, the same is true of housing.   Everyone talks about the wisdom of buying when prices are down, but the fear of future price depreciation deters present buying; everyone wants to wait until they can see a bottom.

Most responsible borrowers need to feel financially secure before purchasing a home.   With a very weak economy, job losses and lack of confidence in the future, most prudent people will think twice before taking on the large financial commitment of owning a home.  The disappearance of 100% financing also means that a buyer faces the loss of his capital investment if the mortgage payments cannot be maintained.

Is it cheaper to rent equivalent housing?  If it is cheaper to rent, does that imply that housing is overpriced?   Have prices been adequately discounted to adjust for past purchases made with easy financing by speculators and unqualified buyers?

A buyer contemplating a home purchase today must consider whether the various government schemes to keep delinquent homeowners in their homes is artificially propping up the market and extending the decline of housing prices.  If a homeowner is unable to pay his mortgage today and with incomes and jobs disappearing, how likely is it that a delinquent homeowner’s income will increase?  Are the loan modification programs and foreclosure holidays making a home buying decision more difficult?  If these programs fail, will the future flood of foreclosed homes on the market cause further large home price decreases?

Is the average buyer today prepared to pay the large maintenance and repairs associated with home ownership?  If buyers today see little chance of future price appreciation, are they prepared to invest a large part of their free time maintaining a home?

Given the large transaction costs of buying or selling a home is it worth purchasing a home unless you know with certainty that you will remain in the home for an extended period of time?  Transaction costs including sales commissions, financing and moving can easily equal 10% of an average home’s value.

Am I really ready to own a home?  In the past, when people foolishly believed that housing values could only go up, this question was rarely asked.  Before considering the purchase of a home, a buyer should discuss in depth with other homeowners the pros and cons of home ownership.  The question of whether to buy or rent has never been more difficult.  A very uncertain housing future and lack of confidence breeds indecision and purchase deferral.

Many of the current problems in the housing market arose due to the easy credit offered to buyers who should have stayed renters.  Buyers should not consider the purchase of a home unless their total mortgage and other debt payments are easily affordable.  Buyers should not use their last dollar of savings when purchasing a home.  Many unexpected expenses will routinely come up.  If you don’t have at least 6 months of income in savings, after your down payment, consider postponing the purchase until your finances improve.   After years of  house buying mania and then a bust, how many confident and strong buyers are out there?

Most mortgage companies and home builders involved with first time home buyers offer advice on determining the affordability of a buyers mortgage payment but do not address many of the other issues discussed here.  Major companies such as KB Homes, for example, discuss the affordability question, but I think more needs to be done in this area.

In the long run an educated buyer with financial stability will be the bedrock of a stable housing market.   Hopefully, future regulations arising from the current housing crisis will address the issue of educating home buyers and make this a mandatory part of the home purchase process.