Consumer Compliance Outlook
An Overview of the Home Affordable Modification Program
On February 18, 2009, President Obama announced the creation of the Homeowner Affordability and Stability Plan (HASP) to help millions of struggling homeowners avoid foreclosure by refinancing or modifying their first mortgages.1 This plan has two primary components: 1) the Home Affordable Refinance Program (HARP), to help borrowers refinance distressed mortgage loans into new loans with lower rates; and (2) the Home Affordable Modification Program (HAMP), to help homeowners at "imminent risk of default" on their mortgages by modifying their loans. In the current economic environment, banks and servicers may find it beneficial to understand the HAMP program.
HOW DID WE GET HERE?
Before discussing HAMP's features, it is helpful to review the government loan modification programs preceding it because many of its features reflect lessons learned from the previous programs.
Streamlined Foreclosure and Loss Avoidance Framework
Servicers play many roles in the mortgage process, but their primary responsibility is to collect payments from homeowners and remit payments to investors. When the homeowner is delinquent, servicers have a fiduciary responsibility to initiate loss mitigation practices that are in the best interest of investors but within the framework established under their pooling and servicing agreements. Because over 70 percent of all residential mortgages are managed by servicers and owned by investors, one of the first government programs to address foreclosures focused on delinquent mortgages held in securitized trusts.
On December 6, 2007, Treasury Secretary Paulson announced a plan to reduce the number of delinquencies and foreclosures among adjustable rate subprime homeowners whose mortgages had been securitized.2 Under the Streamlined Foreclosure and Loss Avoidance Framework, better known as the "Teaser Freezer" plan, mortgage servicers would be encouraged to initiate communication with subprime borrowers and to voluntarily modify their mortgages. Specifically, servicers were encouraged to modify mortgages by freezing the homeowner's introductory interest rate for five years.
Eligibility for the plan was limited to a sub-group of homeowners who acquired their homes using an adjustable rate subprime loan product. Other requirements were that homeowners had to be in relatively good standing on their mortgage and were not able to refinance into a fixed rate or government-insured product. It was also necessary that the mortgage cover an owner-occupied property held in a securitized pool.
The pooling and servicing agreements presented a major obstacle to modifying mortgages. In most cases, servicers are restricted from modifying mortgages without investor approval, and obtaining investor approval can be a challenge for the servicer.
Federal Deposit Insurance Corporation's (FDIC) Loan Modification Program, or "Mod in a Box"
Loan modifications are difficult to implement when the mortgage has been securitized and is being held by investors. But what if the primary owner of a pool of mortgages is a government entity such as the FDIC? After the failure of IndyMac Federal Savings Bank, the FDIC assumed control and initiated a modification program for mortgages securitized or serviced by IndyMac. The requirements for eligibility are that homeowners must be at least 60 days delinquent on their primary mortgage and must have a cumulative loan-to-value (CLTV) ratio greater than 75 percent.
The FDIC Loan Modification Program, or "Mod in a Box," attempts to reduce the homeowner's front-end debt-to-income ratio (DTI)3 using a standardized modification process.4 This process uses a net present value (NPV) tool to evaluate the merits of modifying each delinquent mortgage relative to foreclosure. If modifying a mortgage yields a positive NPV, the program mandates that a modification be initiated. Under the program, the following sequential steps are taken to modify a mortgage:
- Interest Rate Reduction: To reduce the home- owner's front-end DTI ratio to 38 percent, the servicer can reduce the interest rate on the mortgage, but the interest rate cannot fall below a floor of 3 percent.5
- Extended Amortization Term: If the home-owner's front-end DTI ratio still exceeds 38 percent after the interest rate on the mortgage has been adjusted, the mortgage will be amortized out to a maximum of 40 years, with a term no greater than 30 years.
- Partial Payment Forebearance: If the home-owner's front-end DTI ratio still exceeds 38 percent, the last option is to split the debt into an interest-bearing, amortizing portion and a zero percent, zero payment portion of the loan. The repayment of the "postponed" principal will be due when the loan is paid in full.
One problem that "Mod in a Box" and other earlier programs encountered is the decline in house values. Lenders and servicers are unlikely to modify mortgages if they believe homeowners are likely to re-default. Declining house prices increase the risk of re-default because some borrowers are reluctant to continue making mortgage payments when their house value is declining, especially if they are "under water"; that is, the loan balance exceeds the current value of the home. When re-default is likely, the rational choice for a servicer is to initiate foreclosure proceedings when the homeowner becomes delinquent and sell the home at a sheriff's sale.
Hope for Homeowners
To address the shortcomings of previous programs, including the problem of declining house values, the Bush administration announced the creation of the Hope for Homeowners Program (H4H) on October 1, 2008, which allows homeowners to refinance their mortgages with a mortgage insured by the Federal Housing Administration (FHA). To be eligible for the program, the borrower must be seeking to refinance a mortgage on his primary residence and cannot have an interest in any other residential property. Also, the homeowner must have a front-end DTI ratio that exceeds a threshold ratio of 31 percent.
For lenders, H4H currently requires that first-lien holders accept 96.5 percent of the appraised value of the home as payment for all outstanding claims.6 If the first-lien holder accepts this lower principal amount, the mortgage is refinanced into an FHA-insured loan. The homeowner must pay an upfront mortgage insurance premium of up to 3 percent and an annual premium of up to 1.5 percent.7
Streamlined Modification Program
Similar to the "Mod in a Box" program, the Streamlined Modification Program uses an affordability measure to modify mortgages held by government-sponsored enterprises (GSEs). To quickly modify mortgages at risk of default, the program modifies first liens to reduce the homeowner's front-end DTI ratio to 38 percent. Under the program, servicers can take the following actions, in the listed order, when modifying a mortgage:
- To reduce the homeowner's front-end DTI ratio to 38 percent, the servicer can extend the term of the mortgage.
- If the homeowner's front-end DTI ratio still exceeds 38 percent after the term of the mortgage has been extended, the servicer can reduce the interest rate on the mortgage in increments of 0.125 percent. However, the interest rate on the mortgage cannot fall below a floor of 3 percent.8
- If the homeowner's front-end DTI ratio still exceeds 38 percent, the last option available to servicers is to delay repayment on a portion of the principal. The deferred principal will be paid as an additional balloon payment due upon sale, payoff, or maturity.
The eligibility requirements for the Streamlined Modification Program include that the house securing the mortgage must be the homeowner's primary residence and that a GSE must own or must have securitized the loan. In addition, only homeowners who are at least 90 days past due on their mortgage, have documentation that they encountered some financial hardship, and have a CLTV on their home that is greater than 90 percent are eligible for the program. One important innovation of the Streamlined Modification Program is that it provides an $800 incentive payment from the GSEs to the servicers for each mortgage that is modified.
These previous government mortgage modification programs have had mixed results in reducing foreclosures and avoiding re-default, depending on the type of mortgage (prime, subprime, etc.), the type of modification (e.g., reducing the loan payment), and whether the servicer performing the modification is servicing the loan for a third party or in its own portfolio. For example, the Fitch ratings service released a report earlier this year showing the re-default rate for modified subprime, securitized loans was between 65 percent and 75 percent.9 But a recent Mortgage Metrics Report from the Office of the Comptroller of the Currency and the Office of Thrift Supervision, which analyzed the loan performance at nine national banks and four thrifts with the largest mortgage portfolios, found that "modifications that decreased monthly payments had consistently lower re-default rates, with greater percentage decreases [in monthly payments] resulting in lower subsequent re-default rates."10 The report also found the re-default rate for modified mortgages was generally lower if the borrower's payment was reduced by more than 10 percent.11
Another issue with the previous programs is that they were voluntary. HAMP requires that all banks and lending institutions accepting funding from the Troubled Asset Relief Program (TARP), after the announcement of HAMP in March 2009, must implement loan modifications for eligible loans under HAMP's guidelines. For non-TARP banks, participation is voluntary. Institutions participating are required to sign a contract with the Treasury agreeing to review all loans for potentially eligible borrowers who call or write asking to be considered for the program. It is important to note that participating servicers are still bound by the pooling and servicing agreements when modifying loans. However, HAMP still requires institutions to make every effort to help facilitate loan modifications within the constraints of their pooling and servicing agreements.
Under HAMP, all first-lien loans are eligible for modification as long as they do not exceed GSE conforming loan limits of $729,750 for a single-unit property. Other requirements are that the property must be a primary residence and cannot be vacant or condemned. It is also necessary that borrowers experience a financial hardship that hampers their ability to pay their mortgage, leading to delinquency or the risk of "imminent default."12
Similar to the Streamlined Modification Program and "Mod in a Box," HAMP allows servicers and lenders to use a standard process to modify eligible mortgages. Loans are modified to increase their affordability and reduce foreclosures. To accomplish this, servicers are required to determine the monthly mortgage payment a borrower can afford13 and sustain long term and then modify the existing mortgage until the front-end DTI ratio equals 31 percent.14 Fifty percent of the costs incurred to reduce a borrower's front-end DTI ratio from 38 percent to 31 percent are incurred by the U.S. Treasury. Further front-end DTI reductions below 31 percent are allowed but are not subsidized by the Treasury.
To encourage servicers to modify mortgages, HAMP provides servicers with a one-time up-front payment of $1,000 for each delinquent mortgage they modify.15 If the mortgage holder's loan remains current after the mortgage has been modified, the servicer can earn an additional $1,000 per year over a five-year period.16
One concern expressed by the mortgage industry about modifications was that in an environment in which real estate prices are declining, it often makes more sense for lenders to foreclose than to modify a mortgage. If a defaulted loan is modified and the borrower re-defaults, and the property is worth less at re-default, the lender likely would have been better off foreclosing when the original default occurred and the property was more valuable. To address this concern, HAMP provides some protection against falling house values associated with default following modification under the Home Price Decline Protection (HPDP) initiative. Specifically, this initiative provides owners and servicers with cash compensation for making loan modifications on properties located in areas with declining home prices.17
Another important feature of HAMP is that the Treasury requires lenders and servicers to apply a consistent process in calculating an affordable loan modification. In fact, the HAMP approach is similar to the process used in "Mod in a Box": A loan can be modified only if it yields a positive NPV using a "waterfall" procedure. The "waterfall" means that lenders and servicers must follow an established sequential process when applying the NPV test to determine which loan modification to use to achieve a targeted front-end DTI ratio of 31 percent.
The steps of the "waterfall" are as follows:
||Capitalization. Capitalize arrearages, such as accrued interest and past due real estate taxes and insurance payments.
||Reduced Interest Rate. The servicer must reduce the interest rate by increments of 0.125 with a floor of 2 percent, in order to reach the targeted front-end DTI ratio of 31 percent. If the modified interest rate is lower than the Freddie Mac Primary Mortgage Survey Rate for 30-year fixed-rate conforming mortgage loans, the modified interest rate will be in effect for the first five years of the modification.18
||Extended Term. If the targeted front-end DTI ratio cannot be reached by reducing the interest rate, the servicer can extend the term of the loan and amortize the mortgage by up to 40 years from the date of origination.
||Principal Forbearance. If the front-end DTI ratio has not reached 31 percent after reducing the interest rate and extending the term of the mortgage, the servicer can engage in principal forbearance, where no interest may accrue on the forbearance amount. Principal forgiveness can be used at any stage of the "waterfall" but is not permitted on GSE loans. In addition, the U.S. Treasury does not bear modification costs if a mortgage is modified using principal forgiveness.
Revisions to HAMP. On April 28, 2009, the U.S. Treasury announced two enhancements to HAMP. The first clarifies and emphasizes that H4H is the preferred form of loan assistance to the borrower before seeking assistance under HAMP. Servicers are required to evaluate and offer all eligible homeowners the option of having their loan refinanced using the guidelines established under H4H. As an additional incentive to offer H4H to homeowners, servicers will receive a $2,500 up-front payment for every refinancing using H4H, which is higher than the $1,000 up-front payment servicers receive when modifying loans using the "waterfall" approach.19
The second enhancement discusses how second-lien holders are addressed under HAMP. The original announcement was short on details, but on August 13, 2009, the Treasury Department published supplemental directive 09-05 for the Making Home Affordable Program, which discusses in detail the procedure for modifying second-lien mortgages, known as the Second Lien Modification Program (2MP).20 Under this program, "when a borrower's first lien is modified under HAMP and the servicer of the second lien is a 2MP participant, that servicer must offer either to modify the borrower's second lien according to a defined protocol or to accept a lump sum payment from Treasury in exchange for full extinguishment of the second lien. The 2MP offer will be made in reliance on the financial information provided by the borrower in conjunction with the HAMP modification and without additional evaluation by the second lien servicer."
The directive identifies the eligibility requirement for second-lien loan modifications and extinguishment:
- Only second liens with corresponding first liens that have been modified under HAMP are eligible for a modification or extinguishment under 2MP.
- Second liens originated on or before January 1, 2009 are eligible for a modification or extinguishment under 2MP.
- Only second liens with an unpaid principal balance (at initial consideration for the second-lien modification) equal to or greater than $5,000 are eligible for modification incentive or cost share payments under 2MP. There are no unpaid principal balance limitations for investor incentive payments in conjunction with extinguishment of second liens under 2MP.
- A second lien may be modified only once under 2MP.
- A mortgage loan that is subordinate to a second lien is ineligible under 2MP. Modification or extinguishment of such a subordinate mortgage loan in place of the second lien will not satisfy the servicer's obligation under 2MP to modify or extinguish the second lien.
- If a second lien is modified under 2MP, it is not eligible for payment of extinguishment incentives under 2MP.
- A home equity loan that is in first-lien position is not eligible under 2MP and should be evaluated for modification under HAMP.
- A mortgage lien that would be in second-lien position but for a tax lien, a mechanic's lien, or other non-mortgage-related lien that has priority is eligible under 2MP.
- A second lien on which no interest is charged and no payments are due until the first lien is paid in full (e.g., FHA partial claim liens and/or equity appreciation loans) is not eligible under 2MP.
- Borrowers may be accepted into the program if a fully executed 2MP modification agreement or trial period plan is in the servicer's possession on December 31, 2012.21
Compensation for second-lien modification is provided by the Treasury Department. To modify or extinguish second liens, investors, lenders, and mortgage servicers must be active participants in the program. If an interest rate reduction is used to modify the second lien, investors and lenders are paid 50 percent of the difference between the new modified interest rate of 1 percent for a fully amortized mortgage and the original interest rate on the loan. If the investor or lender agrees to extinguish his lien, a payment of 3 percent of the unpaid balance of the loan is distributed if the claim is more than 180 days delinquent. A higher payment is allocated ranging from 4 percent to 12 percent of the unpaid balance of the loan if the claim is less than 180 days delinquent.
Servicers are compensated to modify second liens but receive less compensation for second-lien modifications than for first-lien modifications. For example, mortgage servicers receive a $500 up-front fee to modify second liens. In addition, servicers can receive a payment of $250 per year for up to three years if the second lien remains current. It is also important to note that borrowers can also earn a $250 payment per year for a five-year period if they remain current on their mortgage.22
What Makes HAMP Different? HAMP attempts to address the factors contributing to foreclosure and re-default that were not effectively addressed in the previous government-sponsored loan modification programs. As discussed earlier, the primary factors contributing to foreclosure and re-default are mortgage affordability and home price depreciation. HAMP is expected to be more successful by providing a comprehensive way to affect these factors and by creating new processes to tackle issues. The main changes from prior programs are that HAMP:
- Addresses the issue of who bears the cost by allowing the U.S. Treasury to share 50 percent of the cost to reduce a borrower's front-end DTI ratio from 38 percent to 31 percent.
- Creates an incentive for mortgage servicers to participate in the program by paying servicers a fee to modify mortgages. Servicers can receive additional compensation if the mortgages they modify remain current.
- Compensates investors and lenders as house prices decline on mortgages that are modified to reduce the cost associated with re-default and to encourage participation.
- Modifies mortgages that are current but are at "imminent risk of default."
- Provides a platform that allows lenders and servicers to consistently and uniformly modify mortgages at risk of default. A uniform standard should reduce the cost to servicers and the variation in outcomes, leading to a reduction in foreclosures.
It will take some time before the Treasury Department can evaluate whether HAMP has been successful in meeting its objectives of reducing the number of foreclosures through mortgage modifications. Because HAMP incorporates the lessons learned from previous programs, there is an expectation that it will be more successful. Specific issues and questions should be raised with the consumer compliance contact at your Reserve Bank or with your primary regulator.