Federal Response to the Mortgage Foreclosure Crisis: the Homeowner Affordability and Stability Plan

Dennis Cuevas, Project Director and Chief Counsel, Consumer Protection

Dennis Cuevas, Project Director and Chief Counsel, Consumer Protection

National estimates and data continue to paint a bleak picture of the housing and foreclosure landscape. According to investment firm Goldman Sachs, approximately 13 million defaults will occur between now and 2014. The Mortgage Bankers Association estimates that 1 in 10 homeowners are currently delinquent on their mortgage payments. Meanwhile, mortgage lending in this country has plummeted. In 2008, lending fell 40 percent to $1.61 trillion – down from $2.65 trillion a year before. The National Realtors Association reports that existing home sales dropped 24 percent, while new home sales and new home construction dropped 54 percent and 58 percent respectively.

In an effort to stem the tide of foreclosures and stabilize the housing market, President Obama announced this past February his $275 billion housing plan. The plan would help nine million troubled homeowners refinance their mortgages and stabilize neighborhoods devastated by foreclosures. Dubbed the “Homeowner Affordability and Stability Plan,” the plan has three components: a refinancing program, a modification program, and a Fannie Mae and Freddie Mac strengthening component.

The first component would help homeowners who are current on their mortgage payments, but who are paying high interest rates and cannot refinance because they lack enough equity in their homes, a growing problem as home values continue to fall. The program would give 4 to 5 million homeowners an opportunity to refinance into more affordable monthly payments.

Under the refinancing program, borrowers must be current on their payments (no more than 30 days late on the mortgage payment in the last 12 months), the property subject to refinancing must be owner-occupied, and the loan must be owned or guaranteed by Fannie Mae or Freddie Mac. In addition, eligible loans must not exceed 105 percent of the current market value of the property, i.e., the amount owed on the mortgage is about the same or slightly less than the current value. Lastly, borrowers must show sufficient income to support the new mortgage payments. Interest rates will be based on market rates in effect at the time of the refinance and any associated points and fees quoted by the lender. The refinanced loans will have no prepayment penalties or balloon payments.

The second component of the housing plan is the modification program, which commits $75 billion to keep 4 million Americans in their homes by preventing avoidable foreclosures. It would provide incentives to lenders who alter the terms of loans to make them affordable for troubled borrowers. Although the plan has broad coverage -- the loan balance must be less than $729,750, modification must yield a greater return than foreclosure, and there must be imminent risk of default -- the plan is narrow by requiring that the subject loan originate on or before January 1, 2009, that loans be modified only once under the program, and modifications start from now until December 31, 2012.

Servicer participation [organizations that collect payments from borrowers] in the modification program is generally not required; however, Obama’s housing plan provides several incentives for participation. Servicers that modify loans, according to the Treasury guidelines, will receive an up-front fee of $1,000 for each modification, plus “pay for success” fees on still-performing loans of $1,000 per year. Homeowners who make their timely payments are eligible for up to $1,000 of principal reduction payments each year for up to five years. The program will provide one-time bonus incentive payments of $1,500 to lender/investors and $500 to servicers for modifications made while a borrower is still current on mortgage payments.

In order to obtain these incentives, servicers are required to follow modification guidelines, aimed at reducing the monthly payment to no more than 31 percent of gross monthly income. These guidelines include using a net present value (NPV) test on each loan that is at risk of imminent default or at least 60 days delinquent (NPV is comparing the value of money now with the value of money in the future). The test will compare the NPV of cash flows with modification, as well as without modification. If the NPV of expected cash flow is greater in the modification scenario, the servicer must modify the loan. Modification requires a reduction in the interest rate then, if necessary, extending the term or amortization of the loan up to a maximum of 40 years. Principal forgiveness is also an acceptable alternative. The borrower’s monthly payment must include principal, interest, taxes, insurance, flood insurance, and homeowner’s association fees.

Other guidelines under the program include acceptable discount rates, property valuation methodologies, home price appreciation assumptions, foreclosure costs and timelines, and borrower cure and redefault rate assumptions.

The third component of the plan would increase the credit available for mortgages by giving $200 billion of additional financial backing to government-sponsored enterprises Fannie Mae and Freddie Mac. Increasing the funding commitment to Fannie Mae and Freddie Mac would ensure the strength and security of the mortgage market and help maintain mortgage affordability.

Under the program, the Treasury is increasing its Preferred Stock Purchase Agreements to $200 billion each from their original level of $100 billion each and will continue to purchase Fannie Mae and Freddie Mac mortgage-backed securities. Treasury will increase the size of Fannie Mae and Freddie Mac’s mortgage portfolios to $900 billion, up from $50 billion. These initiatives are aimed at enabling Freddie Mac and Fannie Mae to continue to provide affordable mortgages and provide confidence in the mortgage market.

The Homeowner Affordability and Stability Plan is one of President Obama’s initiatives to revive the economy and stem foreclosures. At its core, the plan will get troubled borrowers’ loan balances below the value of their houses, and it will reduce their payments to a sustainable level. The ultimate success of the program will depend on the participation of troubled borrowers and servicers.

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