- The Washington Times - Tuesday, February 16, 2010

ANALYSIS/OPINION:

The Obama administration’s Home Affordable Modification Program (HAMP) reports that it has generated about 900,000 loan modifications of some type. But the Mortgage Bankers Association in September reported that about 7.5 million households were behind on their mortgages or already well into the foreclosure process. A recent report states that just 30 percent of those homeowners who start the process for a loan modification complete the paperwork. Much more needs to be done, and done soon. The heart of the problem is that for most beleaguered homeowners, the economics of loan modification as it exists simply don’t make sense.

Most modifications depend on the lender reducing the interest rate on a mortgage loan or extending the term. Neither solution helps the financially strapped homeowner enough, so the homeowner does what is logical: He stalls the process to gain time. Further, because of HAMP, banks feel pressured to screen borrowers carefully before approving any loan modification, slowing the process even more.

From the point of view of the homeowner, if monthly payments cannot be made consistently and the house is “underwater,” the best solution is to stop making any payments until the house value rises or the lender takes the house through foreclosure (usually 18 to 24 months). In some states, it is illegal to pursue the homeowner for the lender’s loss, and in most others it is too difficult. The homeowner gets to stay in the house “rent free” for the period. The downside is a ruined credit rating, which, in this environment, just puts him or her in the same position as millions of others. Banks get stuck with lost interest and, most likely, lost principal. Entering into a loan modification that the homeowner cannot fulfill only makes matters worse for the lender by extending the time needed to get to the house and cut the lender’s continuing losses.

If a homeowner cannot make monthly payments consistently because of job loss, lowering the interest rate or extending the term makes little difference and is no help. Take the homeowner with a $200,000 loan at 8 percent for 30 years: The payment is $1,468. Add in real estate taxes and homeowners insurance, and the monthly payment could be close to $2,000. Lowering the rate by half (to 4 percent) reduces the monthly principal and interest payment by just $514, to $954. Extending the term to 40 years in addition only cuts the payment another $118 ($836). A new $1,400 monthly payment, representing a reduction of 30 percent, will be just as impossible to make as the original $2,000 monthly payment. And the homeowner has no incentive to keep paying - why throw “good money after bad”?

So it makes financial sense for the homeowner to stall until he finds another job. The lender cannot do anything but harass the owner until the sheriff’s sale. The homeowner, looking at this financial situation rationally, will pursue one of three alternatives. If the homeowner finds another job before the sale, a modification still can be negotiated; if the house is underwater, let the lender take the house; if the house has value, use the time to sell it.

Three economists at the Federal Reserve of New York, Andrew Haughwout, Ebiere Okah and Joseph Tracy, recently analyzed data from 300,000 modifications, looking at the variables that impact a borrower’s ability to repay, willingness to repay and incentive to repay. The study (“Second Chances: Subprime Mortgage Modification and Re-Default”) confirms what mortgage bankers know by experience: A modest reduction in monthly payments will not prevent a re-default, but a significantly lowered monthly payment, especially if tied to a principal reduction, will. So here is what we propose:

The lender should offer a short-term agreement to collect interest only at current short-term rates (2 percent to 3 percent for two years) plus taxes and insurance, and to stop all collection and foreclosure proceedings for the period. In return, the homeowner agrees to pick up the original mortgage at the end of the short term or pay off the loan through sale or refinance. Also, the homeowner would need to give the lender a quitclaim deed so that the lender would not need to commence or resume the foreclosure process at the end of the term or in the event the homeowner fails to make payments on the short-term agreement.

Our proposal gives the homeowner a two-year period of substantially lower payments (in our example, a 50 percent reduction to about $1,000 a month) to see if the value of the house rises, to find a new job or to sell the house. The lender gets a stream of interest income, albeit significantly lower, and an assurance that it can reach the property quickly if the deal fails. This also should unclog the judicial foreclosure system, which is at a standstill. Finally, the local government continues to receive tax payments on the property.

To sweeten the pot, TARP money could be used to offer a discount on the unpaid principal balance if the loan is paid off early or is revived and the homeowner lives up to the short-term agreement for two years and a period thereafter. A pool of $25 billion could help 1 million homeowners by providing funding equivalent to a 10 percent principal reduction (with a ceiling of $25,000 per loan) at the end of the two-year interest-only term. In this way, the TARP money gets used in a way that resembles its initial intent - to relieve lenders of troubled assets - and at the same time, it provides an incentive for homeowners who now face only anxiety awaiting the sheriff’s gavel.

To implement the policy we recommend, all the administration needs to do is modify the existing HAMP program to permit interest-only mortgage payments. The need is urgent for homeowners, lending institutions and local governments. The administration should act quickly.

Dominick Mazzagetti is president of RomAsia Bank and former New Jersey deputy commissioner of banking. Frank D. Tinari is professor emeritus at Seton Hall University and principal economist of the Tinari Economics Group.

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