Both government and industry have experienced a steep learning curve in battling foreclosures, but two years into the crisis, greater flexibility and more effective measures are combining to produce early signs of improved results.
The Obama administration’s massive $75 billion mortgage modification program launched in the spring is off to what even supporters consider something of a slow start, but it has already proven more effective than any other recent federal effort.
“Part of it has been understanding how big the problem is,” says economist Dean Baker, co-director of the Center for Economic And Policy Analysis “They're also getting more experience about what's going to work and what isn't.”
Though industry players and analysts consider the Obama administration’s program fairly thorough and thoughtful, the modification process is still very labor intensive, involving painstaking analysis and documentation.
The Making Home Affordable program, which was conceived to assist as many as 7 million to 9 million needy homeowners, has offeredabout 325,000 trial modifications since late April, according to the Treasury Department. About 160,000 loans have been modified into lower-cost loans so far.
“There seems to be a ramp up and that’s good, but there are still execution issues,” says Andrew Jakabovics a housing expert at the Center for American Progress. “We're starting to see an impact from the modification program. I don’t think we're at a comfort point yet.”
More importantly, the program is still too young to offer any success rate data, partly because the modifications—which seek to reduce monthly costs through a variety of means including lower interest rates and principal reduction—are based on a three-month trial format. Treasury plans to report its full data on a monthly basis beginning August 4.
Finger In The Dike
The foreclosure situation is certainly not getting better, but some say it may be on the verge of stabilizing. That said, it has definitely become more of a mainstream, Middle America, middle class problem.
What was once the plague of unconventional mortgages—such as subprime and no-documentation loans—synonymous with the easy money days of the credit bubble is now the stuff of prime loans held by more creditworthy borrowers who are losing their jobs to the recession and thus becoming delinquent on their payments.
What’s more, a three-year side in housing prices has put many homeowners under water, such that houses are worth much less than the underlying loans, making it difficult for people to refinance and reduce interest costs on adjustable rate mortgages with ballooning payments.
“I think the perception of the nature of the problem has changed,” says Jakabovics. “I think there is greater political will to do something. I think the drumbeat is only going to get louder. It's very real and very personal and I think Congress and the administration intuitively understand that.”
Attacking The Problem
The Making Home Affordable is designed to help homeowners already in trouble (the loans have become delinquent) and those who may be heeded for it. Loan services receive a fee of $1,000 per loan modification for the former, and an additional $500 for the latter. In addition, they receive a $1000 a year for three years if the modified loan stays current.
The program also covers underwater borrowers. What’s more, the loan-to-value ratio, which started out at 105 percent, is now 125 percent, meaning a homeowner with a $250,000 loan on a property valued at $200,000 is eligible for refinancing aid.
“We need strong refinance opportunities so they don’t go into delinquency and foreclosure,” says Faith Schwartz, executive director of Hope Now Alliance, the mortgage industry’s foreclosure prevention program.
Early intervention and prevention has long been considered a key to greater success in foreclosure mitigation, just as a write down in principal—as opposed to a simple interest rate reduction or extension on the life of the loan—is considered essential in boosting modification success rates.
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Analysts say mortgage industry players are slowly but surely accepting that concept, even if it means eating a bigger initial loss.
“More than half of the modifications in the first quarter of 2009 resulted in lower monthly principal and interest payments, as servicers focused on achieving more sustainable mortgage payments,” the report states.
Modifications that reduced monthly payments by 20 percent or more jumped 19 percent from the previous quarter, to 29 percent of all modifications, according to the data.
Redefault rates after 3-, 6-, 9- and 12-month periods for loans that were reduced by 10-20 percent or 20 percent or more were significantly lower than those with no change in payment.
“To make modifications that stick you have to do something about the outstanding principal,” says housing consultant Edward J. Pinto, a former chief credit officer at Fannie Mae. “Slowing down the inevitable doesn’t so anyone any good.”
With loss severity rates for foreclosures at record highs (in some cases running 40-60 percent of the original loan value), some lenders and services are seeing clear advantages to writing down principal.
“If you can work out a reduced payment plan they get to keep their home,” says Paul Koches, chief legal officer and EVP at Ocwen , one of the nation’s largest servicers. “If we have to foreclose on one, we don’t have the continuing service fee. It’s about finding a repayment plan that is truly sustainable.”
Overall, almost 17 percent of Ocwen's modifications have involved principal forgiveness, with an average reduction of almost $31,000.
Fits And Starts
The MHA has experienced the usual start up problems, which may partly explain its lower-than-expected volume.
Jakabovics, for one, says based on the program’s goal of helping 3 million to 4 million homeowners over two years, he would expect to see 750,000 loans processed in the first six months.
“It’s a very thoughtful and thought threw but it is a very complicated program,” says Faith Schwartz, executive director of the Hope Now Alliance, the mortgage industry’s foreclosure prevention program, which has helped 4 million homeowners since its inception in October 2007.
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Schwartz, Jakabovics and others cite technology and staffing issues in particular for some of the loan servicers.
Thus far, 27 have signed on, including units of all the major financial firms, such as JPMorgan Chase , Citgroup, Wells Fargo , Bank of Americaand Goldman Sachs
“You have to automate this or you won’t be scaleable," says Schwartz ”You have to reprogram [software] systems to integrate with the government program.”
Though some of the services have struggled with integration, Florida-based Ocwen has had no such problems.
“It didn't take us very long to tweak our processes to adjust,” says the company’s chief legal officer and EVP, Paul Koches.
Ocwen has already contacted about 59,000 homeowners under MHA and executed 5,464 modifications.
"The pace is accelerating as homeowners complete their financial packages," explains Koches.
Chase—which services 10.3 million million loans, only a quarter of which it owns—approved 87,000 trial modifications under the program in the April-June quarter, during which time half made their first modified payment.
“We have made terrific progress since April 6 in helping families ... by ramping up our capacity through hiring people, adding office space and investing in technology,” Chase said in a statement.
Since 2007, Chase says it has prevented 565,000 foreclosures, although it won't reveal how many have redefaulted.
Ocwen “cut its teeth” handling non-performing, residential loans during the clean up of the savings and loan crisis in the 1990s, says Koches, which turned out to be good experience in handling the wave of subprime mortgage defaults. The company handled some 80,000 modifications in a 12-month period ending in the first quarter. About 80 percent of the 330,00 loans it services are subprime.
The company says it has spent more than $100 million dollars developing a loan restitution technology platform.
“It allows us to handle modifications properly—one-on one in rewriting the loan and allowing us to find the sweet spot between reduced payment that is sustainable by the borrower and maximizing the net present value [of the home] for the investors,” says Koches. “The president’s plan is very good in capturing those concepts.”
MHA also includes provisions for what many consider last-ditch, but less costly alternatives to foreclosure, such as short sales and deed in lieu.
(In a short sale, the borrower is allowed to to sell the property at its current value, even if less than the value of the mortgage, while with a deed-in-lieu transaction, the borrower transfers ownership to the servicer.)
Ocwen also anticipated increased staffing needs, almost doubling its home retention unit to 324 people since 2007. Another 42 work in an early intervention unit.
Though MHA is well regarded and well received, it is not without shortcomings.
Some say the program does not go far enough and that eligibility rules are somewhat arbitrary.
Lawrence Yun, chief economist at the National Association of Realtors, notes that MHA only covers loans that are backed by Fannie Mae and Freddie Mac, which covers only about half of the 55 million outstanding mortgages. He also questions whether there should be any restrictions for underwater homeowners, given the steep decline in home prices in some markets.
“The program should address the fairness issue," says Yun, and "be more proactive in addressing underwater homeowners who have been responsible and are making payments on time, rather than focusing so much on people who are defaulting. That gives a perverse incentive for people to default.”
That’s been a long–running criticism of most foreclosure mitigation programs while the fairness issue—many admit—is a tricky and elusive one.
Thus far, the Obama administration appears to be responsive to both criticism and suggestions for improvement.
It is implementing an audit mechanism for applications that been rejected, which may be meant to address the criticism that the program has no appeal process.
It is now considering expanding Making Home Affordable to unemployed homeowners, as the jobless rate inexorably heads to 10 percent.
And in a broader effort to minimize the impact of foreclosures on the housing market as well limit individual financial hardship, the administration says it is considering a proposal that would allow people who have lost their homes to stay on as renters.
“The fundamental problem that they are up against is to come up with a structure of incentives for everyone to play,” says economist Baker, who has been advocating the foreclosure-renter concept since August 2007, when the subprime mortgage issue first flared brightly.
Despite all the tinkering, the administration appears a bit impatient. In a recent letter to servicers, the government asked them to "expand servicing capacity and improve the execution quality of loan modifications" and attend a meeting with senior Treasury and HUD officials on July 28 to "discuss full implementation of the program."
“I don’t think the administration’s plan has proven to be a magic bullet yet,” says Pinto. “We have to work through this; it is a long process.”