Nolo’s Bankruptcy & Foreclosure Blog

Yesterday a client asked me whether he should start defaulting on his mortgage payment. He got word from his lender that his payments might be substantially reduced in the future, but only if he was at least three months behind when he applied for the modification program. More than anything, the idea that you have to miss payments to get help with your mortgage defines the trouble we are in.

On November 11, Secretary of the Treasury Henry Paulson announced just such a plan for mortgages owned by federal housing agencies Freddie Mac and Fannie Mae. Unfortunately, these entities own only a small percentage of the outstanding sub-prime mortgages -- the type that give rise to most of the foreclosures. According to Sheila Bair, head of the Federal Deposit Insurance Corporation (the regulator of most of the nation's banks), this policy only addresses the tip of the foreclosure iceberg. The FDIC is pushing its own program that may prove to be the centerpiece of the Obama plan.

According to the Treasury announcement, your Freddie or Fannie mortgage payments will be reduced to 38% of your pre-tax income by lowering your interest rate and extending the term of your mortgage. Oddly, this 38% figure is nearly 10% higher than the standard ratio previously used by lenders to determine affordability. In other words, your modified Fannie or Freddie mortgage will be technically unaffordable by a large margin. Huh!

In tandem with this new Fannie and Freddie mortgage program, the federal government continues to offer (under the HOPE for Homeowners Act) 30-year fixed rate FHA-insured mortgages for homeowners at risk of foreclosure. While you don't have to be behind on your payments to participate in this program, it does require your mortgage owner to voluntarily cash out the current loan at something short of your home's current appraised market value (just how short will likely range between 3% and 10%, due to amendments included in the bailout bill). So far, very few lenders have stepped up to the plate. And homeowners aren't all that thrilled either since they would have to share at least 50% of any future equity they develop with the federal government.

It's important to keep in mind that federal foreclosure mitigation policies are being fashioned by a few individuals who likely will not be around on January 20, 2009. Also, the Democrats' majorities in the House and Senate will be enhanced. As the economy continues to deteriorate and a new government takes hold, radical -- and unpredictable -- changes in the federal government's approach to the foreclosure epidemic are virtually guaranteed.

If you want to know about what modification opportunities are available for your mortgage right now, whether under the federal programs or under other programs operated by private mortgage owners, you'll need to find out who's calling the shots and what type of plan they offer. Consider using a free HUD-certified housing counselor to help you get this information. You can find a counselor in your area by calling 1-888-995-HOPE.

Effective October 1, 2008, the federal HOPE for Homeowners Act was created to help homeowners avoid foreclosure. Homeowners who qualify may be able to refinance their currently unaffordable variable rate mortgages into affordable 30-year fixed rate mortgages insured by the Federal Housing Administration (FHA), provided their lenders agree to accept the terms of this new program.

For the program to work, lenders must be willing to accept buyouts of their loans that will provide the lender with 90% or less of the current appraised value of the home. For instance, if an appraisal shows that your home is worth $200,000, your lender would have to agree to cash you out at $180,000, regardless of what you owe on the mortgage.

Not only the primary lenders, but also the holders of second or third mortgages, will have to sign off on the deal -- and there's nothing forcing them to do so. In truth, people with second and third mortgages will have trouble qualifying for a new mortgage under this program.

If you eventually hope to make some money off your home, this program is probably not for you. Homeowners who receive refinancing under the HOPE for Homeowners program will be required to share a portion of any future appreciation in home value with the federal government. In other words, if you sell or refinance your home, you may have to send some of the profits to the feds. The amount will range from 100% to 50%, depending on when the property is sold or refinanced. And if there was an additional mortgage holder in the business, he or she may also be entitled to a share of the appreciation.

Not everyone will qualify for refinancing under this program. Basically, you must be at risk of foreclosure under regulations being developed by a new regulatory agency. You will have to document your income, and it must be adequate to make the new loan affordable under standards set out in the National Housing Act. You have to be living in the house you are seeking to refinance and you can't own any other real estate. Finally, you must certify that you haven't intentionally defaulted on your mortgage or any other debt, and that you didn't furnish false information when you obtained the mortgage you seek to refinance.

To find out more about this program and whether you qualify for it, you should seek assistance from a free, HUD-certified nonprofit housing counselor. For a list of these counselors, see HUD's website at www.hud.gov (click on "Avoid Foreclosure", under the "Homes" column) or call 1-800-569-4287. You can also call 1-888-995 HOPE.

Earlier this week, the House of Representatives shot down the Emergency Economic Stabilization Act of 2008, popularly known as "The Bailout". The Senate picked it up, passed easily after adding $100 billion and change in pork to buy some more votes from House Republicans, and the House is now expected to vote on it tomorrow (October 3). Meanwhile, despite predictions of doom and gloom by the folks pushing this bill, life and the stock market go on.

There is much to be said about this legislation from various perspectives -- political, economic, and financial -- but here I want to contradict an oft-expressed opinion: that homeowners facing foreclosure are not being helped by the bailout legislation.

The basic idea afloat out there is that absent a provision in the bill that would authorize Chapter 13 bankruptcy judges to modify residential mortgages and interest rates, the homeowners are being left high and dry. Not true. While such a bankruptcy provision would benefit a portion of the population in mortgage trouble, many more folks facing foreclosure either don't have sufficient income to propose a viable Chapter 13 plan, or just can't afford the legal fees.

While Chapter 13 can also be useful in scheduling missed payments over the course of the repayment plan, many -- if not most -- homeowners can afford to both keep their mortgage current and pay an extra amount into a repayment plan every month to pay off the arrears. Further, if missed payments are the only problem, many lenders are now amenable -- outside of bankruptcy -- to extending the loan period and tacking the missed payments on at the end.

Simply put, Chapter 13 is a relatively narrow remedy in the larger foreclosure context. The language in the failed legislation, on the other hand, would provide much broader relief to homeowners facing foreclosure. Here's why.

Under the bailout legislation, in a large number of foreclosure situations, the federal government will be involved in one way or another. That alone will be somewhat of monkey wrench in the foreclosure gears. But that's not all: All the government agency players will have to have a plan under which they will seek to keep homeowners in their home. This plan will provide a legal basis for advocates and housing counselors to push for meaningful modifications and relief from foreclosure.

While the federal agencies (and mortgage servicers, in cases where the mortgages continue to be privately owned) will have to take the impact on taxpayers into account when negotiating a mortgage workout, they will likely be willing to modify the mortgages down to the market value of the property, or even below, since the legislation prefers that mortgage workouts take place within the context of the HOPE for Homeowners Act as amended by section 124 of the Emergency Economic Stabilization Act. Further, the Government will, where appropriate, facilitate conversion of the old loan into a 30 year fixed-rate FHA insured mortgage as provided for in the HOPE for Homeowners Act.

In short, because of increased government involvement with foreclosures under a mandatory plan that encourages retention of home ownership, many more homeowners will be able to keep their homes than previously, and for those who don't qualify for help, the foreclosure machine is likely to be gummed up beyond all imagination. From my standpoint, this is a very good thing.