The Obama administration’s announcement late last month that it will revamp its foreclosure prevention efforts by adding loan write-downs to banks’ tool-kits has generated considerable optimism that more loan modifications will stick.
But a handful of analysts are tempering that optimism by pointing out that many of these programs face some of the same obstacles that have hampered others: The programs are voluntary and they require borrowers to document their incomes and qualify for a modification or refinance.
The administration will introduce two ways for borrowers to have their loan balances written down:
Under the first, borrowers who are current on their loans but owe more than their homes are worth might be eligible to refinance into a smaller loan backed by the Federal Housing Administration. That program, the FHA “short refinance,” is voluntary and investors must agree to to take at least a 10% haircut to get the first mortgage down to 97.75% of the property value.
Short refinancing will face the same hurdles that have snagged others before it, including the presence of second-lien mortgages or mortgage insurance and the fact that a refinance that results in any forgiven principal could ding a borrower’s credit score. “After accounting for all these potential hurdles, the number of strong candidates for this program drops sharply,” says a report from analysts at Barclays Capital.
Barclays estimates that around 2-4% of most borrowers with loans that were bundled and sold into securities could ultimately be eligible for the FHA initiative. The effort appears to be targeted towards those loans that have been sold to private investors as opposed to those backed by Fannie Mae or Freddie Mac, which already have their own programs to refinance underwater borrowers.
The second program represents an expansion of the existing Home Affordable Modification Program, or HAMP. Currently, banks modify loans under HAMP by lowering interest rates and extending loan terms in order to bring a borrower’s mortgage payments to 31% of their income. Banks don’t have to modify the loan if it is less expensive to foreclose on the home, using prescribed formulas. Borrowers must have missed payments or be facing “imminent default” and must demonstrate hardship.
But the program is being expanded so banks must consider writing down loan balances under HAMP for “underwater” borrowers who owe more than 115% of the value of their home. To guard against moral hazard, those borrowers won’t see their loan balances reduced unless they stay current on their modified loan for three years.
Barclays estimates that 20%-40% of all HAMP applications could be eligible for principal write-downs.
Credit Suisse analysts figure that around 5% of loans backed by Fannie Mae and Freddie Mac, or around $255 billion, could be far enough underwater to qualify for these write-downs. Of that amount, around 15% could already be delinquent, while another 20% could become delinquent over the next year.
The administration announced its changes to HAMP after early signs that the program wasn’t living up to initial expectations. Barclays analysts hypothesize that the changes were announced as it also became clear that HAMP was beginning to exhaust the number of borrowers that could be helped. Of the nearly six million borrowers who are 60 days or more delinquent, about one third are eligible for HAMP, and around two-thirds of that pool has already been offered a trial modification.
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