March 2009 Archives

March 11, 2009

The New Federal Housing Plan: A Good Start

On February 17, the Obama Administration announced its new homeowner affordability and foreclosure prevention plan. On March 4th, the Treasury Department issued guidelines as to how the new plan would be implemented. Despite criticism from all sides, I think the plan is about as good an approach as is possible in the current political and economic climate.

Many articles and blogs that are critical of the program have pointed out the obvious -- that the plan won't apply to many who could use the help, or even to the majority of people at risk of foreclosure, especially those who are losing their jobs at such a rapid rate. There will be widespread injustices in that many people who deserve to get help will fall outside of the guidelines and an equal number of people who get help may arguably not deserve it. The plan is structurally insufficient given the lack of adequate funding. The mortgage modification part of the plan will crash and burn when (not if) the investors sue because they feel it favors the banks and homeowners and neglects their interests. And so on and so forth.

The fact is, there is no way to create a massive housing relief and foreclosure prevention program without its share of problems -- big problems. Still, the Administration's plan appears to successfully thread a very thin needle by making large and hopefully permanent improvements in the home mortgage landscape while avoiding the worst of the moral hazard bunkers -- a political necessity.

The plan consists of two components: a $400 billion refinance program and a $75 billion mortgage modification program (all to be paid out of previously allocated funds). Setting aside the details for a moment, the programs will likely accomplish two important goals:

  • The refinance program will potentially transform millions of funny-money loans with uncertain interest rate futures into stable, 15- or 30-year fixed-rate low-interest mortgages. Payments on the refinanced loans will increase in some cases, but the homeowner's participation will depend on his or her ability to afford the new loans. And even though their payment may be higher in the short term, it will be stable in the long term -- no more fear of interest resets. While the refinance program only applies to mortgages owned or backed by the two large federal housing finance agencies -- Fannie Mae and Freddie Mac -- we're talking about half of the nation's mortgages. Overall, the program is bound to have a substantial -- and positive -- effect on the mortgage default rate and the stabilization of home prices.
  • Equally important, the mortgage modification program creates a workable approach to modifying mortgages so that payments for many will be brought within the affordability range. Also, for the first time, homeowners can get an objective fix on whether they are eligible for a modification. It's impossible to say what the future holds for the real estate industry, but it makes sense to believe that once mortgage lenders become comfortable with the very idea of modifying loans, only good things will follow. Whether or not the number benefiting from this program will be in the millions -- as predicted by the Administration -- or in some lesser amount doesn't really matter. The overall numbers are sure to be large.
Getting back to the details, let's continue with the refinance program: Even if you have a shot at this program because your mortgage is owned or backed by Fannie Mae or Freddie Mac, you will only qualify if what you owe on the mortgage is within 105% of the home's current value. For example, if your property is valued at $200,000, you won't qualify for refinancing unless you owe $210,000 or less on your first mortgage. This means you probably won't benefit from this program if you live in the areas most heavily impacted by the housing crisis -- home values in these areas are frequently 25% or more below what's owed on the mortgage. You also will probably be disqualified if your loans are jumbo rather than conforming (over $417,000 in most areas, and $729,750 in higher-cost areas like New York and California).

But suppose you're lucky and live in a part of the country where you're just a little upside-down, within the 5% range. Even then you'll need a good payment history (some say good credit is also required) and an income that is adequate to afford the payments under the new loan, which, as mentioned, may be higher than under your current loan, at least for a little while.

In the final analysis, the homeowners who least need a refinanced mortgage are the most likely to get one, and vice versa of course. And this says something very important about both of the new programs: They were carefully crafted so that the Obama Administration could credibly assert that only responsible homeowners would be helped. They didn't want to defend themselves against the allegation that we taxpayers were rewarding bad behavior -- the moral hazard quandary. In the case of the refinance program, only homeowners who have a good payment history and who aren't very much upside down are getting to play. Homeowners who somehow got in way over their head or who have shirked their payment duties will likely not be invited to the party.

The Administration's attempt to only help responsible homeowners is also evident in the mortgage modification part of the program. To qualify for a modification you have to show:

  • financial hardship caused by change of circumstances, such as loss of a job, a medical emergency, or an interest-rate reset (if you were in over your head from the beginning, it's unlikely you'll qualify for help)
  • risk of foreclosure, meaning you have missed at least two payments, or your debt to income ratio (your DTI) is higher than 31%, and
  • sufficient and provable steady income (by way of a tax return and wage stubs) to make the payments required under the modified loan.
The ball starts in the mortgage servicer's court. All participating mortgage servicers (so far, most of the big ones have signaled their willingness to play along) must perform an initial "net present value" (NPV) analysis on all loans in their portfolios that are either at least two months delinquent or that are in "eminent risk" of default. Although the guidelines don't define what "eminent risk of default" means, I assume it means loans with a debt to income ratio in excess of 31%.  A loan's NPV is what it would cost (in cash flow) to modify the mortgage relative to the cost of foreclosure and is to be calculated according to parameters set out in the guidelines. Based on past practices, most NPV analyses will favor modification and in those cases the servicer will be required to notify you, proceed with modification discussions with you, and modify the mortgage, assuming you meet the other eligibility requirements.

The ultimate goal for the modification program is to adjust the interest rate and duration of the mortgage so that the homeowner has a debt to income ratio (DTI) of 31% (meaning the payment on the first mortgage, including taxes and insurance, will be 31%of the homeowner's gross income; the mortgage debt that goes into this DTI ratio doesn't include payments on a second mortgage, installment payments, or mortgages on other houses).

The modification is to be accomplished by first reducing the interest rate to as low as 2% and then by extending the term of the mortgage (from its inception) to a maximum of 40 years. Once the payment (through this process) reaches a DTI of 38%, the government will share the cost of the rest of the reduction down to 31%. The servicer also has the option of modifying a mortgage loan by reducing its principal -- with government participation and backing. Last but not least, the program provides monetary incentives to servicers for keeping people in their homes and to lenders for agreeing to modify the mortgage. 

Both programs are designed to operate without the need for homeowners to come forward with a request for assistance. Rather, the servicers will be contacting people for a follow up after their initial eligibility for a modification or refinance has been established. Nevertheless, it would be a good idea for you to consult with a HUD-Certified Housing Counselor to see whether you are being treated fairly under the new plan. To find a counselor, call 1-888-995 HOPE.

Under no circumstances should you pay a counselor for his or her services. A bevy of mortgage brokers have been retrained to modify mortgages under the new plan (in fact, a new trade organization has been created just for "loan-modification experts") and are charging outrageous fees for doing absolutely nothing that a HUD-certified housing counselor won't do for free. Some new mortgage modification companies are hiring lawyers to be front-people for them so that fees can be collected in advance (something that many state laws prohibit). And it's true that lawyers can sometimes be very helpful in preventing foreclosures as such. But, as with mortgage brokers, lawyers have no magic keys to the kingdom of mortgage modifications. Again, for that purpose, you and your wallet will be better off with a HUD-certified counselor.
March 4, 2009

Cars in Chapter 7 Bankruptcy -- What Happens?

People often ask me about how Chapter 7 bankruptcy will affect their ability to keep their car. If you aren't making payments on a car, then it's just a matter of using whatever exemptions are available to keep it, just like any other asset. However, if you are making payments on your car, it's not so simple. As part of your bankruptcy you must decide how you want handle the note. You do this by filing an official form called the Statement of Intention (SOI) with your other bankruptcy papers as well as mailing a separate copy of the SOI to your lender. I go into more detail on this in a new article on Nolo's website: What Happens to Your Car in Chapter 7 Bankruptcy?
March 2, 2009

Lobby Your Congressional Representative in Favor of HR 1106

Sometime this week, the House is expected to vote on H.R. 1106, the bill that would allow Chapter 13 bankruptcy judges to modify residential mortgages. Right now, judges cannot modify mortgages attached to the bankruptcy filer's principal residence.

Without question, an enormous number of homeowners facing foreclosure would be able to keep their homes now and in the future if the principal owed on their mortgage could be crammed down to the home's current market value in a Chapter 13 bankruptcy (and the interest rate reduced to the bare minimum). Not only would foreclosures be avoided, but Chapter 13 itself would become much more available as a remedy, since many Chapter 13 plans fail because of the non-affordability of the filer's mortgage payments.

Previously, I've argued that Chapter 7 judges should also be allowed to modify mortgages, since so many more people file Chapter 7 than Chapter 13. However, half a loaf is better than none, and allowing Chapter 13 judges to bring mortgages into line with the value of the home would not only benefit the filer but would also provide a powerful brake on the deterioration of the residential real estate market.

You can lobby your representative by calling 1-877-354-4958 between 9AM and 6PM Eastern Standard Time only. You will be given specific suggestions for the substance of your phone conversation and prompted to enter your zip code, but the basic idea is that you favor passage of the bill.

Depending on your Congressional district, your call will be routed to the office of your Senator, your House Rep, or the White House.