Consumer Compliance Outlook
Foreclosure Prevention Activities and the Community Reinvestment Act
"Troubled borrowers will always require individual attention, and the most immediate impacts of foreclosures are on local communities. Thus, the support of counselors, lenders, and organizations with local ties is critical. This situation calls for a vigorous response. Measures to reduce preventable foreclosures could help not only stressed borrowers but also their communities and, indeed, the broader economy."
Chairman Ben S. Bernanke, "Reducing Preventable Mortgage Foreclosures," at the Independent Community Bankers of America's annual convention, Orlando, Florida, March 4, 2008
The mortgage crisis has been front-page news for many months and has taken a toll on both consumers and lenders. Its effects include:
- A sharp increase in loan delinquencies and foreclosures for residential real estate mortgages, which are likely to continue to rise;
- A large number of borrowers who face the possibility of losing their homes and any accumulated home equity in foreclosure, damaging their credit record for several years, restricting their access to credit, and increasing the price of any credit they are able to obtain;
- A slowdown in home price increases, including declines in some areas, that has left many new homeowners with little or no home equity; and
- An increase in the number of borrowers who have difficulty obtaining refinancing (the typical way for some to avoid the payment shock of large, scheduled interest rate resets) because of declining real estate prices and, for some loans, negative amortization.
Because of the large increase in delinquencies and foreclosures of residential mortgage loans, foreclosure prevention activities may be a primary need in many local communities. Banks can play an important role in preventing foreclosures. By helping to address residential mortgage problems within their local communities, banks may also receive favorable consideration under the Community Reinvestment Act (CRA) for certain activities that are consistent with safe and sound banking practices. These activities can include counseling, loan refinance, loss mitigation, and loan modification. This article discusses ways for banks to help borrowers in distress while simultaneously fulfilling their CRA obligation.
Foreclosure Prevention Activities
On July 11, 2007, the federal banking agencies requested public comment on a series of new and revised interagency questions and answers pertaining to the CRA (2007 Q&A).1 Although the agencies have not yet issued the final version of the 2007 Q&A, some of the proposed revisions relate to foreclosure prevention and indicate how such activities will be evaluated in the future if the proposal is adopted as the final version without modification. The proposed revisions are expressly intended to encourage banks to work with homeowners who are unable to make mortgage payments by making foreclosure prevention programs available for low- and moderate-income homeowners. The proposed revisions state that community development services include providing credit counseling, financial planning, and other financial services education to promote community development and affordable housing. This includes credit counseling to assist borrowers in avoiding foreclosure on their homes. The revisions also state that qualified investments include investing in or donating to a fund providing foreclosure relief to low- and moderate-income homeowners.
Consumer Literacy and Education Counseling
Consumer literacy and education efforts, typically in the form of counseling, may help address the problems distressed borrowers face, especially if these efforts are undertaken in the early stages of delinquency. Counseling organizations provide information about and assistance with managing delinquencies, budgeting, negotiating with lenders, and understanding foreclosure laws. When it is not feasible for a distressed borrower to remain in the home, counselors will provide information about pre-foreclosure sales. Some counseling organizations go beyond providing information to distressed borrowers by offering special loan programs. For example, the Minnesota Housing Finance Agency offers a loan program through nonprofit organizations to provide mortgage payment and other financial assistance to borrowers facing short-term crises.
The New York Times recently published a front-page story about the successful efforts of the Belair-Edison Neighborhood Initiative, a community group in Baltimore that conducts counseling and outreach activities, to help distressed borrowers in the Belair-Edison neighborhood.2 The Belair-Edison Neighborhood Initiative Initiative searched public records and coordinated with other housing groups to identify borrowers with high-interest or adjustable-rate mortgages and contacted them to discuss lower-cost alternatives. Its efforts paid off. For the period 1993-2003, Belair-Edison had one of the highest foreclosure rates in the city, but the rate has since dropped by a third, which is largely attributed to the efforts of the Belair-Edison Neighborhood Initiative.
In Minnesota, a statewide association has defined its mission as providing support, networking, and information to people and organizations working in the field of mortgage foreclosure prevention and promoting sound policies and practices both in the public and private sectors related to foreclosure prevention counseling. It operates on three fronts: providing support, information, and networking for individuals and organizations working to prevent foreclosures; educating and training housing professionals to improve the quality and availability of mortgage foreclosure prevention programs and services; and advocating policies and practices that enhance foreclosure prevention counseling.
Banks can support these types of associations by serving on their boards of directors, counseling distressed borrowers, and educating housing professionals. Bankers have the specialized knowledge and skills that associations need to manage loan programs for distressed borrowers. As previously noted, counseling activities may count as community development services because the activities are targeted to help meet the needs of low- and moderate-income individuals and thus have community development as their primary purpose.3 In addition to counseling services, banks can provide support to associations through investments, donations, or loans, all of which can count as a community development activity. Banks working either alone or in conjunction with other organizations may receive favorable CRA consideration for providing counseling in the area of foreclosure prevention4 because such activities target low- or moderate-income individuals and thus may count as community development services under the CRA's definition of community development.
During the course of counseling, distressed borrowers might seek to refinance the original mortgage loans that have caused their financial distress. Often, however, distressed borrowers are precluded from refinancing because of their delinquent status, lack of equity, or impaired credit. Despite these challenges, refinance loan programs with flexible underwriting standards may be available.
For example, the Department of Housing and Urban Development's (HUD) new FHASecure5 loan program offers qualified borrowers who are delinquent because of an interest-rate reset the opportunity to refinance into an FHA-insured mortgage. This loan program allows FHA-approved lenders to refinance adjustable-rate mortgage loans that have recently reset or will reset in the near future. To be eligible under the FHASecure program, a borrower must have, among other things, a history of on-time mortgage payments before the teaser rate expired and the loan reset.6 Lenders will not automatically disqualify distressed borrowers because of delinquency status, and some may offer second mortgage loans to make up the difference between the property value and the amount owed, including standard refinancing costs.
HUD recently expanded this program by adding two new categories of borrowers eligible to participate: 1) borrowers with adjustable-rate mortgages who were late on two consecutive monthly mortgage payments or at two different times over the previous 12 months, for which the FHA will require a 97 percent loan-to-value (LTV) ratio; and 2) borrowers with adjustable-rate mortgages who were late on three consecutive monthly mortgage payments or at three different times over the past 12 months, for which the FHA will require a 90 percent LTV.7 HUD estimates that the expanded program will enable approximately 500,000 borrowers to refinance distressed mortgages into an FHA-insured mortgage with an attractive rate.
Banks can develop in-house refinancing programs or participate in third-party or government loan programs offering flexible underwriting standards like those described above. However, not all banks have the capacity to develop loan programs or make loans through third-party or government programs. In these cases, banks might simply take applications and provide settlement services to distressed borrowers; this type of activity can receive favorable consideration as a retail banking service or community development service under the CRA provided the activities are targeted to help meet the needs of low- and moderate-income individuals and the programs follow prudent underwriting standards.
Banks often ask examiners to treat loans that are especially responsive to the needs of low- and moderate-income borrowers as community development loans for CRA purposes. However, under the CRA regulations, a refinance loan involving a distressed borrower is not a community development loan.8 These types of loans might, nonetheless, receive positive consideration under the CRA if they are made to low- and moderate-income borrowers or in low- and moderate-income areas. First, these loans can be captured in the analysis of the bank's home mortgage lending and might result in further strengthening of the bank's lending performance to low- and moderate-income borrowers and in low- and moderate-income areas, depending on the level of activity. Second, a bank's practice of making such loans might receive positive consideration
as responsive or as an innovative or flexible lending practice, which is a performance criterion for large banks.
When foreclosure prevention in the form of refinancing is not available to a distressed borrower, the next option to consider may be loss mitigation (also known as a forbearance plan or loan workout) with the lender. Some lenders will establish repayment plans for past-due payments. The repayment plan will typically require a payment in addition to the regularly scheduled payment under the original mortgage loan.
Loss mitigation arrangements are not viable for all distressed borrowers, but they may be appropriate for those who have experienced a reversible financial setback, such as a job loss, medical situation, or divorce. The federal banking agencies encourage financial institutions to consider prudent workout arrangements that increase the potential for distressed borrowers to keep their homes.9 When evaluating workout arrangements, banks should follow prudent underwriting practices. When prudent, some workout arrangements might be considered innovative or flexible lending practices under the CRA.10
Bank efforts in loss mitigation might involve either direct or indirect financing. Sometimes the loss mitigation activity may count as community development, and sometimes it may not. For example, if a bank makes a direct loan to a distressed borrower to cover the amount of a delinquency, the loan will not be counted as a community development loan, since it will most likely be categorized as a consumer or other retail loan under the CRA.11 On the other hand, if a bank makes a loan to or an investment in an organization that provides these types of loans to low- and moderate-income borrowers, the loan or investment may count as community development. Even though a loss mitigation loan directly from a bank to a distressed borrower will not count as a community development loan, such activities might positively reflect on the bank under the CRA, as discussed above under loan refinancing.
Another option for a distressed borrower may be a loan modification. A modification can sometimes benefit both the borrower and the lender by reducing the losses that would accompany foreclosure and sale of the property in a declining market. A loan modification is a permanent change in the terms of the original mortgage loan. In such cases, the monthly payment is reduced by permanently lowering the interest rate, extending the maturity date, or writing down the principal balance of the loan. A loan modification might also limit interest-rate adjustments to the current market rate plus a reasonable margin, convert an adjustable-rate mortgage to a fixed-rate loan, or capitalize delinquent principal, interest, or escrow items. The loan modification option may be appropriate for those distressed borrowers who cannot cope with the higher payments associated with a repayment plan under a loss mitigation arrangement or who face long-term problems making mortgage payments.
The federal banking agencies have stated that banks engaging in activities that move low- or moderate-income homeowners from high-cost loans to low-cost loans may receive favorable consideration under the CRA.12 Loan modifications are not considered refinancings unless the existing loan obligation is satisfied and replaced with a new obligation; thus, loan modifications are not evaluated as home mortgage loans under the CRA. Since loan modifications often have the same results as refinancings, they can be evaluated under the CRA if the bank presents data about the modifications for consideration.13
CRA Activities After Foreclosure
Even when the loss of a home through foreclosure or some other process is not prevented and a property reverts to the bank, CRA consideration may be given depending on how the bank disposed of the property. The bank can receive credit for making a qualified investment by donating the property to an organization engaged in community development. For example, the bank might donate the property to an organization providing affordable housing to low- or moderate-income individuals or an organization that provides community services targeted to low- or moderate-income individuals. Donations of properties might even count as efforts to revitalize or stabilize low- or moderate-income areas or distressed or underserved nonmetropolitan middle-income areas. For example, the Neighborhood Housing Services Redevelopment Corporation in Chicago has acquired hundreds of abandoned properties from such sources as the Department of Housing and Urban Development, the city of Chicago, bank foreclosures, and private owners. Sometimes the properties are rehabilitated and sold to new owner-occupants. In highly depressed housing markets, the worst-quality units are often demolished to mitigate safety hazards and reduce supply.
Similar programs are developing in metropolitan areas across the nation. Under the CRA regulations, the value of the donation involving a discounted sale of a property is generally the difference between the market value and sales price of the property. If the bank transfers the property with no sale, the value of the donation is the market value of the property. Donations might be appropriate for some banks on a case-by-case basis to respond to the needs of low- and moderate-income people or revitalize and stabilize low- and moderate-income areas or designated distressed, underserved or disaster areas.
"The issues surrounding each mortgage delinquency or foreclosure vary, as does the solution that is best for helping a particular borrower. Thus, loss mitigation and foreclosure intervention efforts typically involve customized assistance in order to devise remedies appropriate to the situation. Fortunately, many community leaders, government officials, and lenders across the country are now collaborating to develop approaches and protocols to help borrowers who are experiencing mortgage delinquencies avoid foreclosure."14 Banks are well positioned to provide the specialized assistance needed by individual distressed borrowers. By taking the opportunity to fulfill the needs of distressed borrowers, whether through loans, investments, or services, banks will likely receive favorable CRA consideration for the activities. Specific issues and questions about this article should be raised with the consumer compliance contact at your supervising Reserve Bank or with your primary regulator.