President Obama’s Foreclosure Rescue Plan: Loan Modification Analysis

Underwater homeowners looking for a bailout from President Obama’s Foreclosure Rescue speech might be wise to think very carefully about all the possible consequences of grabbing the new loan modification offer. The White House press release on the full plan is located here. President Obama’s plan offers homeowners in trouble a helping hand, at the expense of all the other taxpayers who didn’t speculate, but let’s put aside our outrage for now. Instead, let’s look at whether or not the loan modification program is a good decision.

Clearly everyone is in a unique situation but there are some commonalities within the group we’ll call People Seeking Loan Modifications. I am openly stereotyping for the purpose of making this blog article general instead of case study specific. People Seeking Loan Modifications (PSLM) are typically folks who had a certain level of income when they purchased the home, and today that income has been dramatically reduced. Some may be facing a rate increase or a payment recast if negative amortization has pushed the principal balance to, say 115% or 125% LTV. Most purchased at 100% LTV, some decided on interest only loans, or interest only for a set period of time, in order to achieve a lower payment, speculating that future appreciation would bail them out at the next refi. They have two big problems: Negative equity AND an unaffordable payment.  PSLM typically have other consumer debt as well as mortgage debt. When income drops off a cliff, PSLM use credit cards to pay for routine expenses. By only offering a modest rate reduction, I predict that the re-default rate on these new loan modifications will be easily over 50% and I’m being optimistic. A rate reduction only solves half the problem. Their monthly housing expense has been reduced but their other expenses have not gone away. (If When the banks are nationalized it will be a lot easier to offer rate reductions on credit cards and perhaps that will be in the next bailout proposal.) There IS a solution for the typical loan mod seeking homeowner; President Obama wants principal balance cram downs in bankruptcy. Now the homeowner has to make a sacrifice: Trash my credit record for 10 years with a BK in exchange for getting a financial matrix reboot.

The key to whether or not a loan modification under the new program will work rests with the homeowner: What is the homeowner’s income today v. when he/she obtained the mortgage loan? Many of these folks have been laid off, some were living on extended overtime as a regular part of their monthly income, others were commissioned salesmen with flatline commissions during 2008, some had to take mandatory salary reductions, and still others have had NO disruptions in income but were qualified at the teaser rate of an Option ARM. What if the homeowner has no job at all? Does the homeowner get a zero percent interest rate loan? I’m thinking no, so how do we underwrite this loan and make a determination if this loan mod will fail? PSLM are high risk borrowers and re-defaults will likely occur. But the theory goes that if we can slow the foreclosures to the pace of a river instead of a flood, then doing so *might* help stabilize neighborhood home values and prevent even more foreclosures.

The Tim at SB reminds us to consider that when speculation occurs, foreclosures are a natural part of the solution and may not always be a negative, especially when a homeowner is far better off renting a similar home for far less than the (even modified!) mortgage payment. Home values fall and people who can afford to purchase do so. This begs the question: Do modified mortgage payments really help homeowners? The answer is, it depends on the homeowner.

In order to project future performance, it is important to visit past efforts in helping homeowners face foreclosure.  Past performance: FHA Secure: Projected to help 80,000 Actually helped 266. Hope for Homeowners: Projected to help 400,000 actually helped 312. Projections for President Obama’s loan modification program are that it may help 3 to 4 million homeowners. I project it will help far less. Perhaps we’ll break a thousand this time. This new plan appears to be a bailout for the banks, disguised as a bailout for homeowners. Same siren as FHA secure and H4H, she’s just wearing a different dress.

Will this piece of the Foreclosure Rescue package from the President help stabilize falling values? No. Instead, it will just flatten out the cliff diving and extend the pain that much longer.  From CR:

“For homeowners there are two key paragraphs: first the lender is responsible for bringing the mortgage payment (sounds like P&I) down to 38% of the borrowers monthly gross income. Then the lender and the government will share the burden of bringing the payment down to 31% of the monthly income. Also the homeowner will receive a $1,000 principal reduction each year for five years if they make their payments on time. This is not so good. The Obama administration doesn’t understand that there were two types of speculators during the housing bubble: flippers (they are excluded), and buyers who used excessive leverage hoping for further price appreciation. Back in April 2005 I wrote: “Housing: Speculation is the Key [S]omething akin to speculation is more widespread – homeowners using substantial leverage with escalating financing such as ARMs or interest only loans.” This plan rewards those homebuyers who speculated with excessive leverage. I think this is a mistake.

Another problem with Part 2 is that this lowers the interest rate for borrowers far underwater, but other than the $1,000 per year principal reduction and normal amortization, there is no reduction in the principal. This probably leaves the homeowner far underwater (owing more than their home is worth). When these homeowners eventually try to sell, they will probably still face foreclosure – prolonging the housing slump. These are really not homeowners, they are debtowners / renters.

About Jillayne Schlicke

Educator in the field of mortgage lending and real estate. Follow me on Google+

Comments

  1. The message seems to be if you’re anticipating a drop in income, buy a house. The government will adjust your paymentsdown to whatever you can afford.

    It sounds similar to Hyundai’s latest marketing campaign, except that you get to keep the house.

  2. Hi rob-u-blind,

    I think the banks are going to drag their feet on this, just like they did with FHA Secure and Hope 4 Homeowners. What’s the hurry? Why move fast if the homeowner is continuing to pay each month?

  3. Just who is the latest bailout, designed to subsidize re-financing for struggling home-owners, supposed to help? It certainly doesn’t help the people are already saddled with debt loads they can’t afford.

    http://msurkan.podbean.com

  4. Homeowers. I like it. I’m sure it’ll become houseowers at patrick.net.

  5. I’m pretty skeptical that this will make a difference. Homeowners who have lost income won’t be able to afford any reasonable payment (reasonable to their loan terms). Homeowners who haven’t lost income should still be making payments. “Investors” who’s rents or flips don’t cover expenses shouldn’t receive a government subsidy. I’m guessing the remaining pool is small.

  6. As I posted on Bubble. Here in lies the problem.

    http://www.cnbc.com/id/15840232?video=1039849853&play=1

  7. THANK YOU, JILLAYNE. All caps doesn’t quite get at the tone, so i’ll just say: that’s heartfelt.

  8. It seems pretty obvious we are going to have to write off everybody who bought a house from 2005 on. They should have seen it coming. It doesn’t matter that they had to buy a house because of job relocation or they were young and trying to start out by buying their first house. They are just losers. Capitalism doesn’t distinguish between virtuous and reckless losers. They are just losers and the lucky ones who didn’t get caught can thump their chests are give their victory howls.

    Now say we let the market take its course. House values start plunging to 2002 levels, 2000, 1995 levels even. Layoffs mount and otherwise virtuous and lucky people are swept up in the storm. What happens when a whole generation is lost. People lose faith in all financial institutions, the stock market, banks. What then? Do you think the market will “correct itself” before that happens? Do you think our society can absorb that much dislocation?

  9. Terbor wrote: “say we let the market take its course. House values start plunging to 2002 levels, 2000, 1995 levels even. Layoffs mount and otherwise virtuous and lucky people are swept up in the storm. What happens when a whole generation is lost. People lose faith in all financial institutions, the stock market, banks. What then? Do you think the market will “correct itself

  10. We will see a return to pre 1995 value levels and a systemic 15% to 20% unemployment rate. Some governments will collapse altogether. Some already have. In order to maintain the privileges of the wealthy we will need to undertake a much larger investment in prisons, police and security. We will need to increase our defense spending to protect ourselves from the failed nations that have nuclear weapons and we will need to conscript the able body unemployed into forced military service and labor to keep social unrest at bay.

  11. Actually I misspoke, I did not mean to say the privileges of the wealthy, but rather the privileges of the lucky ones who don’t want to pay for their neighbors bad luck. Subsidize their mortgage or subsidize their prison cell take your pick.

    I belive the free market is all powerful. It will rule in the end. Just be prepared to accept the consequences because they are not always pretty.

    I know that some are going to argue that prison cells versus mortgages is a false dichotomy. Prison cells are a lot more expensive because you have to provide health care, food and clothing as well. Just a different kind of socialism.

  12. Sniglet wrote: “A great and wonderful thing?”

    Wonderful for those who don’t have to experience it.

    And by the way when Japan saw its markets collapse it was still surrounded by a generally strong world economy. Plus the Japanese would rather commit suicide than cause a social disturbance. I suppose if we instituted mandatory capital punishment for any civil disobedience we could cut down on the social unrest factor dramatically.

    As to whether the US weathers this downturn gracefully we will see. The Great Depression was anything but graceful. It took the greatest socialist stimulus package of all to undo, World War 2. I laugh at the money being proposed to solve the current problem. The Republicans are right, all the New Deal did was string out the problem. What they won’t admit is that it took a gigantic socialist program to finally reset the economic equilibrium button. They fought FDR every step on the New Deal and insured that it was never anything more than an anemic fix. It wasn’t until the jobless were conscripted into the army and employed in the defense plants that the nation finally got back on its feet.

  13. Sorry to be so dark Jill, these boards are a good place for people to vent. I do think we are seeing the pendulum swing toward a larger government role in the economy and away from the hands off policies of the past. It is the nature of things. However, I do think we need to be mindful of the consequences of doing nothing.

    Right now the most frightening thing is that I think that anyone who is old enough today to be aware of what is going on with the bank failures, Hedge Fund scandals and stock price collapses will never again trust the banks or Wall Street again. Once that confidence has been destoyed it will only be rebuilt slowly. Becasue of that we will see very little wealth creation in those arenas. The government will need to fill the gap for awhile. That is why I am concerned about a lost generation.

  14. “A provision for homeowners who [...], were coached to commit mortgage fraud,”

    Oh please. Committing mortgage fraud should automatically disqualify you from receiving any benefit (indeed, you should count yourself lucky that you are not being sued or prosecuted). Saying, “the bad man hypnotized me into signing legal documents stating that my income was five times what it actually was (and besides, how else was I supposed to afford the house?)” as an excuse is completely bogus. If your signature was forged or fraudulent documents were submitted without your knowledge, that is one thing – willingly going along with mortgage fraud is quite another.

  15. Jillayne:

    Been busy, mostly refinancing folks who don’t fit any of these criteria, into good low fixed rates. Low LTV, Good FICO, jobs, etc.

    I think your comparison to the 2 previous failures was reasonably predictive of this plan’s future failure. All 3 plans are voluntary, and banks just aren’t gonna do something that puts them one step closer to the Banker’s Graveyard.

    Any bets on when the new admin funds (or allows) 100% down payment assistance again?

    I predict no later than November 09.

  16. Jillayne:

    Been busy, mostly refinancing folks who don’t fit any of these criteria, into good low fixed rates. Low LTV, Good FICO, jobs, etc.

    I think your comparison to the 2 previous failures was reasonably predictive of this plan’s future failure. All 3 plans are voluntary, and banks just aren’t gonna do something that puts them one step closer to the Banker’s Graveyard.

    Any bets on when the new admin funds (or allows) 100% down payment assistance again?

    I predict no later than November 09.

  17. “Any bets on when the new admin funds (or allows) 100% down payment assistance again? ” since they’re allowing 105% LTV’s for refi’s…why not?

  18. Trebor,

    bank failures, Hedge Fund scandals and stock price collapses will never again trust the banks or Wall Street again.

    People will still use banks. They are now talking about putting money in savings. Stock will decline to sustainable levels at about 6000 or a little less. The system will go on as it always has.

    Can you imagine that people are refinancing houses today? Good FICOs with equity going in to take on a new mortgage. It’s new paper to be traded.

    If we revert to the mid 1990 levels of pricing there is only a readjustment of core values. Wages have seen a slow increase compared to the cost of goods. Getting back to a point where a wage earner can buy goods for cash will make the economy more sound.

    What is broken is the credit markets. They may take a long while to readjust to being fair. When we lose interest income we lose profits. Those paper profits are what are now driving the stock market. Before is was the tech sector, after it was the housing sector, now it is, or was, the financial sector.

    Rapid expansion is just different from sustainable growth. We have the ability to stabalize our global market place. It is painful to watch, but equilibrium needs to be established. It’s just a period of adjustment.

  19. Trebor,

    bank failures, Hedge Fund scandals and stock price collapses will never again trust the banks or Wall Street again.

    People will still use banks. They are now talking about putting money in savings. Stock will decline to sustainable levels at about 6000 or a little less. The system will go on as it always has.

    Can you imagine that people are refinancing houses today? Good FICOs with equity going in to take on a new mortgage. It’s new paper to be traded.

    If we revert to the mid 1990 levels of pricing there is only a readjustment of core values. Wages have seen a slow increase compared to the cost of goods. Getting back to a point where a wage earner can buy goods for cash will make the economy more sound.

    What is broken is the credit markets. They may take a long while to readjust to being fair. When we lose interest income we lose profits. Those paper profits are what are now driving the stock market. Before is was the tech sector, after it was the housing sector, now it is, or was, the financial sector.

    Rapid expansion is just different from sustainable growth. We have the ability to stabalize our global market place. It is painful to watch, but equilibrium needs to be established. It’s just a period of adjustment.

  20. C. DE LA says:

    This country and our Government of today does not understand truely how we can “FIX IT” they are just playing guessing games and are not focusing on the true problem and the true resolution. I wish I had my voice heard and I would open the eyes of all.

  21. Hi, my name is Mike. I am trying to get a lower loan from my bank such as what Obama has made promises about. Now no one is enforcing this policy and my broker is upset because we did everything that we needed to do, and yet the bank is stalling or doesn’t want to do it. As you know, the taxpayers bailed out the banks. Would you please give me a phone number to contact someone about this problem. I’m not the only one in this situation. Thank you.

    • I know what you mean, Mike. I am in the same situation. My hours were cut in half at work. Therefore, the income that we bring in barely covers our bills and I find myself juggling which ones I’m going to pay this month and which I am going to put off for next month. My mortgage company says that I don’t qualify for Obama’s plan because I have a MSHDA / FHA loan. I saw nothing in the paperwork about that being a problem… I keep looking everywhere online that state’s that I wouldn’t qualify because of that… But I still haven’t found anything. I think that it’s their way of not WANTING to do the home modification and accepting lower payments. I wish I could find a legitimate company out there that could answer that question…

  22. Hi mike,

    Are you trying to get a new refinance through a mortgage broker or are you trying for a loan modification (both are under President Obama’s new plan.)

    I’ll be at the computer all night so fire away.

  23. Hi mike,

    Are you trying to get a new refinance through a mortgage broker or are you trying for a loan modification (both are under President Obama’s new plan.)

    I’ll be at the computer all night so fire away.

  24. Mike:

    Banks are not required to play along. The Feds are only saying they will buy the loans the banks are willing to make, as long as they meet the criteria.

  25. Hey Mike, I just wanted to let you know that what Roger has said is THE CASE…I myself inquired about the loan modification through our mortgage company( who I would also add, is beginning to outsource their mortgages to India). That is one of the main reasons I called. My husband is in the automotive industry, so far we have done without 2 days of pay a month for all of 2009, doing the math adds up to about 2400 dollars this year. I was also told that OBAMAS plan…doesn’t require BANKS to participate……what a DISGRACE……These LENDERS are nothing but THEIVES.!! They tried to justify their lack of wanting to participate by saying….WHAT if the market begins to improve and your home value increases , would you call us and want us to raise your interest rate back up….”WOW”,,,,such intelligent folks we have in these banking industries….Arrogance will only get you so far…..and then ..you die along with the rest of us hardworking TAXPAYING….BAILOUT GIVING….folks…I wish I could cuss…but it wouldn’t pay me to do so. Heaven help us!!

    • Marta, hire an attorney to take a look at your case. Do not hire an attorney-backed loan mod firm. Do not pay any money up front to a loan mod salesman. Hire an attorney for one hour. Might cost you 100-200 dollars. A competent attorney will be able to tell you if you have a chance of getting a reasonable loan modification. If you do not have any money for an attorney, contact your state bar association and ask for a referral for free legal aid.

  26. Hi Karen,

    There’s nothing in the guidelines that states whether or not banks and lenders are required to modify state housing authority loans. Banks and lenders are free to create their own rules and guidelines. If you started at the state housing finance level, why not return to those same people who helped you get that loan? Many state governments have given lots of money to non-profit housing agencies to help counsel homeowners just like you. You might be able to receive help from a HUD-approved counseling agency on all your possible options.

  27. I just had my hours cut at my job, my home now is depreciated and I can’t get a refinance. Heaven help this county. I feel so sorry for all the upcoming homelessness.

  28. Olonzo Clayton says:

    I was a countrywide customer and was offered 3 loan modifications due to hardship. We were following every guideline that we were told by countrywide to follow and made every payment on time. When countrywide sold to bank of america we then were notified that we didnt have modification recorded and we were 19 payments past due. We tried several attempts to work with Bank of America including reapplying for another modification. We contacted an attorney to assist us with the issue and still was denied. We received notification March 11, 2011 that we only have two option left and thats to short sale or deed in leu of foreclosure. This is our home and we do not want to loose it we did everything that was asked of us and because Countrywide didnt record the modification or advise us we didnt have a modification now were in jeopardy of loosing our home. My wife and I are military I am active duty and shes a Gulf War Veteran we need help and contact any and everyone to help us. Please help we dont want to loose our home.

    Thank You
    Olonzo Clayton

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  1. [...] Jillayne Schlicke of Rain City provides a lot of information and asks the very important question: [...]

  2. [...] just received a very official sounding recorded message informing me that President Obama has a new program to help save my home–it’s NOT a refinance.  If my rate is over 7% or if I’m [...]

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