What you must know now about the new federal anti-foreclosure effort.
By William Streeter, editor in chief,
Answers to some questions about the FHA program, which was due to begin Oct.
The financial wreckage of recent weeks means that potentially thousands of people around the country, and especially in the New York metro area, could soon be joining the ranks of those who cannot make their mortgage payments. That represents an ironic twist that may have more than a few people thinking, “just desserts.”
Whatever your view on that, their situation swells the ranks of homeowners facing foreclosure without some help, which will only prolong the downward spiral of home prices.
Title IV of the Housing and Economic Recovery Act, signed into law in July, could provide some relief—not just for Lehman Brothers employees, but potentially for hundreds of thousands of at-risk borrowers. Entitled “Hope for Homeowners,” Title IV is a voluntary program that permits the Federal Housing Administration to refinance up to $300 billion in loans, providing guarantees (really insurance) on refinanced loans to help distressed users of subprime, Alt-A, and other exotic loan types move into fixed-rate mortgages they can afford.
“Permits” doesn’t quite describe the intense political pressure FHA and its parent—the Department of Housing and Urban Development—are under to get the program ramped up quickly, and to have it assist large numbers of people. The start date was set for the first of this month, and as of mid September, FHA was working feverishly to meet that, with the help of banking regulators, one of whom—the FDIC—sits on the program’s Oversight Board, along with Treasury and HUD.
The following Q&A on the program was put together from various sources. These include ABA materials; interviews with two bankers, both mortgage lending veterans; and input from FHA. Some details of the program were still being hammered out as this was being written.
What is the goal of the program?
Basically to prevent foreclosures. “To provide aid to distressed borrowers currently trapped in mortgages they cannot afford,” to quote from FHA’s consumer-oriented Hope for Homeowners website (www.hopeforhomeownersprogram.org/). By preventing foreclosures, the program would help stabilize neighborhoods and home values, and, on a larger stage, help restore confidence, liquidity, and transparency to the credit markets.
Who can participate?
Borrowers who owe more on their houses than the house is worth and whose current mortgage payments are unaffordable. The refinance program is only for owner-occupied properties and only for mortgages made on or before Jan. 1, 2008. FHA has established a mortgage debt-to-income ratio (including insurance and taxes) of 31% as a proxy for being unable to afford payments. The Oversight Board may move the ratio higher.
In contrast to many of the no-doc and stated-income loans that are being refinanced, the new FHA program requires documentation, with some exceptions. Initially two years of tax returns were to be required, as well as bank account information, job histories, and credit scores. But because many borrowers who got in trouble with adjustable loans probably wouldn’t have gone that route if they could have provided income documentation, as one of the bankers explained, FHA became concerned that program participation could be curtailed. So in mid September the agency acknowledged it was moving to adopt a trial qualification plan as an alternative to tax returns. The general idea is if a borrower could make payments for, say, three months under the program, they could then qualify for FHA insurance.
What will they get?
A new FHA insured, fixed-rate loan for a term of no less than 30 years with a principal amount of no more than 90% of the current appraised value of the property.
In other words, the borrower instantly has equity in the home, and, in most cases, substantially lower payments. Plus they have a fixed rate. In return for this they pay an annual fee to FHA of 1.5% of the principal, and agree to share any future appreciation of the home with FHA on a sliding scale (100% if sold within a year).
Why would a lender/servicer participate?
It’s voluntary so they don’t have to. But if they do, they are agreeing to a principal write-down to 87% of the current appraised value of the property (90% minus a 3% origination fee), and to acceptance of that amount as payment in full for the old loan, waiving any penalties or fees on the existing mortgage. The dollar size of the “haircut” could vary considerably depending on where the property is located.
One of the bankers provided this sample analysis:
A house was purchased for $150,000 with a loan for $135,000. Now, however, the house is worth just $100,000. Under the program, the new FHA loan can only be for $90,000. The bank would accept that amount as payment in full, minus a $3,000 origination fee for a total of $87,000. The bank, in other words, would forgive $48,000. On the other hand, the risk of default is now borne by FHA.
The decision to participate or not, the banker continued, depends on whether you think that going through the long process of foreclosure will net you less than $87,000. If you conclude that you could get $98-99,000 for the house, and even after deducting all your costs you would still be north of $87,000, then you would probably foreclose. But if it’s a market you’re not too sure about, and it could take nine months or longer to get possession of the house, you may conclude that the house might only be worth $80,000 a year from now, and you’ll probably net only $60,000 after costs, so the FHA deal would be great for you.
What about the investor?
A lender or servicer can’t simply write down principal without the okay of the owner of the loan, whether it’s Fannie Mae or a sheik in Dubai.
Fannie Mae and Freddie Mac, since they’re part of the government now, will likely put out guidance regarding loans they own. One of the bankers, envisioned it reading something like this: “We expect you to go through the regular loss mitigation process, and if you’ve tried all those things and they’ve failed, and the borrower is interested in the Hope for Homeowners program, here are the things you have to do. As long as you do these things, you can refinance one of our loans.”
The typical Fannie and Freddie conforming fixed-rate loans, however, are not the loans that the law was crafted for. The two GSEs did buy subprime and Alt-A securities and hybrid ARMs, but these are a relatively small percentage of their assets. A much bigger percentage of troubled mortgage loans are in private label securities. In that case the servicer has to determine what is allowed by the prospectus that governs that transaction. Most prospectuses would give the servicer leeway to do a short sale, one banker stated, if an economic analysis shows it to be advantageous. (A short sale is when a lender agrees to accept less than the full amount of the outstanding balance as payment in full when the property is sold.) But the Hope for Homeowners program is, in essence, a short refi—because the borrower is not selling the house, but is just paying off the loan and refinancing into another loan. This is uncharted territory.
It gets even more complex. Let’s say you have a loan that is part of a security that was tranched. There is a triple A piece and five subordinate pieces—double A, single A, single B, etc. Depending on whether you’re dealing with the investor in the first loss position, i.e., the single B position, or the investor in the triple A position, there might be very different views of whether you should accept a short refi. The triple A investor might say, “Well, the loss on this loan is going to be 15% of the principal, but my tranche doesn’t take any loss until [for example] the cumulative losses exceed 20%. So go ahead.” But for the investor in the first loss position, that haircut might wipe out his entire position. He might say, “I think it’s a moral hazard and a bad precedent. No thanks.”
Further, with securities like this, who knows where the paper has been traded?
The next question addresses a possible solution to one part of this issue.
Is there a safe harbor from lawsuits?
The legislation does offer a safe harbor for servicers, but as of mid September, no details had been released. Until that issue is resolved, it will be a major hurdle to participation in this program if the documents governing the transaction are not clear about allowing servicers to take a step like this. But many banks service loans that they own, and for those, it’s an easy decision to make.
What about second lien holders?
Their position is not entirely clear yet, except that the program requires “all subordinate loans to be extinguished.” The Oversight Board, however, is authorized to allow existing second lien holders to share in future appreciation in value, according to one summary of the law. But as of mid September, FHA had not announced any further details.
One of the bankers we spoke with predicted the eventual outcome would reflect the typical practice now used in the case of a short sale. He explained that in order for the second lien holder to release its lien, which you need in order to deliver a clear title to the buyer, you pay a fee to the lien holder. It’s typically cents on the dollar. It would likely be similar on an FHA refi, with the possibility of giving the subordinate lien holder a certificate of shared appreciation instead of, or in addition to, a fee. Still, said the banker, second lien holders will effectively be wiped out, with perhaps the hope of some future recovery.
Will banks participate?
Most of this lending will be done by the institutions that currently service the loan. Because there is such a concentration in this country of loan servicing, the vast bulk of the loans for which the government is hoping to help people is concentrated in the hands of a few servicers, and they’re all FHA approved.
That said, the comments of one of our two bankers—from a mid-size servicer— shed light on what’s involved in the decision beyond simply dollars. He said: “We’re going to look very closely at it. We are wary about the consequences of being known as a bank that forgives principal. We will look at potential participants very much case by case and make an economic decision based on what the outcome would be in terms of the sale of the property versus the proceeds we would get from the program. If it would net about the same, we do believe that putting fewer homes on the market is good, in terms of clearing the inventory overhang—assuming that the borrower has a good chance to succeed under the revised terms. But we have not to date forgiven any principal—this would be a first for us, so we would have to carefully review each situation.” BJ