Barely a month old, the Administration’s Home Affordability Program is going back to the drawing board to resolve an issue that has tied up the modification of billions of dollars of worth of secondary mortgages and home equity lines of credit and threatens the future of the $75 billion program to keep 3 to 4 million families from foreclosure.
The plan announced March 4 did not spell out how second loans would be handled. Left to be addressed in the “details,” the issue has exploded into a full-fledged war between competing financial interests.-different groups of servicers and investors who hold first or second liens on millions of homes.
Only first mortgages are eligible for a modification under the Obama program but the Treasury Department wants lenders to forgive or to significantly write down secondary loans in order to make modifications possible. In the modification process, reducing subordinate loan indebtedness is critical. Although second liens are not calculated into the 31 percent target ratio of debt to income necessary to qualify for a modification, they are counted in the 55 percent “back end” threshold on debt to equity to compute the likelihood that a borrower will remain current on future payments. Second mortgages and home equity lines of credit are added to borrowers’ total debt burden, and may push them over the threshold, requiring them to participate in housing counseling provided by a HUD-approved housing counselor as a condition of getting the modification.
One proposal reported in the Wall Street Journal last week would require lenders to cap monthly payments on second loans at a set percentage of the borrower’s gross income. The lender would be expected to “eat the vast majority” of the cost, with the government subsidizing a small portion, according to an administration official.
Secondary loan holders are refusing, arguing they purchased mortgage backed securities in good faith and that the Administration lacks to authority to limit or wipe out their investments. Primary loan holders counter that the first mortgage is the main mortgage and in the event of non-payment of the loan the primary mortgage lender gets paid before the second mortgage lender. The higher risk incurred by secondary mortgages is reflected in the higher rates they generally enjoy compared to pr8imjary mortgages.
The roadblock could slow implementation of the Administration’s program. Modifications by most lenders are not yet underway and moratoria on foreclosures remain in effect through April. Many borrowers will not be able to more forward until the question is settled; about half of all seriously delinquent borrowers have a second mortgage debt, according to Credit Suisse. According to the Journal, Administration officials had hoped to announce a resolution last week, but instead they find themselves in the middle of a pitched battle with no consensus in sight.
Leaving treatment of subordinate loans to the “details” phase may have been a mistake made by a new and ambitious Administration still learning the ropes. It also might have been anticipated. Secondary liens were a major cause of the failure of last year’s “HOPE for Homeowners” program. Also designed to help troubled homeowners modify their mortgages before suffering foreclosure, H4H required all holders of liens on a property, no matter how many or how large, to agree voluntarily to reduce or forgive their loans. For borrowers to get participation by their primary lender was difficult enough; getting participation by secondary lenders, who might very well end up with nothing at the end of the process, was virtually impossible. Not surprisingly very few did and only a handful of borrows even applied for relief under the program.
Even though secondary mortgage investors assume greater risk than primary mortgage holders, look for the Treasury to find a way to accommodate them, perhaps by sweetening the pot just as has for servicers through performance fees and for borrowers through prompt payment incentives. Otherwise, the prognosis is could lead to significant delay just as servicers gear up for modifications. Investor lawsuits could complicate and delay the resolution of this issue for months to come.
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