Image: Bryan Tiffin
Michael Goulding,  /  Zuma Press file
Bryan Tiffin checks e-mails while at the family's dining table. The Tiffins, of Portola Hills, Calif., are facing foreclosure.
By John W. Schoen Senior producer
updated 3/4/2009 8:45:08 PM ET 2009-03-05T01:45:08

The Obama administration’s plan to help head off millions of foreclosures came into clearer focus Wednesday when the government issued detailed guidelines governing which homeowners will qualify and how lenders will go about refinancing their mortgages.  But Treasury officials conceded it may not know for some time just how many of the estimated 9 million borrowers targeted by the $75 billion plan will be able to stay in their homes.

“It is imperative that we continue to move with speed to help make housing more affordable and help arrest the damaging spiral in our housing markets,” Treasury Secretary Timothy Geithner said in a statement.

Since the housing market began to unwind nearly two years ago, the process of refinancing troubled loans has been mired in a legal thicket created by Wall Street packaging trillions of dollars worth of home mortgages, chopping them up into pieces and selling them to investors.

Mortgage servicers — originally hired to funnel payments from homeowners to investors — have been swamped by an avalanche of calls from borrowers trying to refinance loans, many of which were unsustainable from the day they were issued. Automatic rate increases and a rising wave of layoffs have put millions more homeowners at risk of default.

Under the plan, mortgage servicers will first apply a standard test to decide if investors would lose more money by foreclosing than they would by issuing a new loan with more affordable terms. Because servicers have been using a wide range of methods to make this calculation, a standard formula is expected to speed the approval of more affordable loans. The government is also hoping to speed the process by letting servicers use an automated system to value a home in place of individual appraisals.

The Treasury’s program, announced Feb. 18, aims to reduce monthly payments to no more than 31 percent of a borrower's gross monthly income. The plan is also designed to determine more quickly which borrowers can be helped — and which ones can’t.

"This is about doing the foreclosures that should be done,” said Susan Wachter, a professor of real estate at the University of Pennsylvania's Wharton School of Business. “The foreclosure mitigation that's going to happen here, these modifications are in the interest of the banks.”

The plan pays loan servicers up to $4,500 for each loan they modify. Those who participate  have to follow a common set of guidelines.

Struggling homeowners also will have to leap several hurdles to be eligible to a new loan under the “Making Home Affordable” initiative. The program runs through 2012.

Borrowers are only allowed to have their loans modified once, and the program only applies to first-lien loans made Jan. 1, 2009, or earlier. Up to 4 million borrowers are expected to qualify.  Another 5 million borrowers who have mortgages held by government-controlled mortgage finance giants Fannie Mae and Freddie Mac should be eligible to refinance through June 2010.

Treasury officials said Wednesday they are still ironing out key details. One involves a major sticking point for many servicers who have tried to modify mortgages to more affordable terms: How to handle the millions of homeowners with second mortgages or home equity loans. Lenders or investors holding those second liens typically suffer the biggest losses when primary mortgages are modified, so winning their approval to modify loan terms has been difficult. The Treasury is working on a plan to let primary mortgage servicers compensate second lien holders, but those details have not been worked out.

The plan also offers no "safe harbor" provision to shield mortgage servicers from lawsuits by investors holding the securities backed by a loan being modified. By making the mortgage more affordable, those investors have to accept a lower return. Though standardized guidelines will clearly streamline a process that has overwhelmed many servicers, those who have declined to modify mortgages based on contract language may still face legal liability.

Treasury officials also said the program’s terms mean that it will be available only to "responsible" homeowners who didn’t buy more house than they could afford. But there was no strict test to determine that standard for eligibility.

The plan details announced Wednesday don’t include a key provision supported by the administration to allow bankruptcy judges more leeway to modify loan terms if servicers decline to do so. That change in the bankruptcy law requires Congressional approval.

On Tuesday, House Democrats agreed to narrow proposed legislation. Under the revised terms, judges would have to consider whether a homeowner had been offered a reasonable deal by the bank to rework his or her home loan before seeking help in bankruptcy court. Borrowers also would to prove they tried to modify their mortgages. A vote in the House was expected as early as Thursday.
The administration is hoping to help two major groups of homeowners who are at risk of losing their homes. The first are those whose income isn’t big enough to keep up with their monthly payment. Some were tricked into signing loans that ‘reset’ to unaffordable payments; some were approved for a loan that consumed more than half their monthly income; some lied about their income on the loan application; and others have lost their job since taking on the loan.

A second, and growing, group of borrowers now owe more on their mortgage than their house is worth. Roughly one in five homeowners with mortgages is in this category. Many have tried refinancing to a lower rate, but lenders currently won’t loan more than 80 percent of a home’s value. Under the Obama plan there is no upper limit on this loan-to-value ratio. But Treasury officials said that, as a general rule, homeowners who owe more the 150 percent of their home’s current market value probably won’t be able to be helped under the plan.

Here’s how the process is supposed to work:

Eligibility requirements:

Only some homeowners will be eligible. To qualify:

  • You must live in your house, condo, or co-op.  (Manufactured homes not attached to a foundation don’t qualify.)  If you’ve abandoned your home or rented it out to help make your mortgage payments, you won’t be eligible.
  • You’ll have to verify it’s your primary residence with a tax return, credit report, utility bill or other document.
  • Borrowers in bankruptcy may be eligible.
  • Your loan has to be less than $729,750 for a single family house; for multifamily homes the cap rises to $1.4 million for a four-unit house.
  • There are no limits on the ratio of the size of your loan to the current market value of your house: Homeowners who are substantially “underwater” can apply.
  • You also have to show that you’re either in default or about to face default. And you’ll have to sign an affidavit saying you can’t afford your mortgage.

What happens then?

Once the servicer determines the value of a modified loan will be higher than the value of the home in foreclosure, they’ll use a three-step process to bring monthly payments down to the government affordable target of 31 percent of your monthly income.

First, they’ll lower the interest rate to as low as 2 percent. Based on the program set up by FDIC Chairwoman Sheila Bair to modify loans held by the failed IndyMac bank that was seized by the government last year, some 70 percent of eligible borrowers are expected to be offered affordable terms based on these interest rate cuts alone, according to Treasury officials.

Next, if cutting interest rates doesn’t bring payments down far enough, the servicer will stretch out the term of the loan to 40 years. Extending the term brought payments to another 20 percent of IndyMac borrowers to within the 31 percent income threshold, said Treasury officials.

If those two steps aren’t sufficient, the servicer can opt to take part of the unpaid principal and roll it into a so-called “balloon” payment when the loan comes due or when the home is sold. Various proposals have been floated to try to get lenders to forgive principal; this allows them to defer repayment, rather than forgive, a portion the loan amount.

The means some of the potential losses to lenders from the drop in home values could be pushed into the future. It also means the government is not guaranteeing to cover those losses. 

The plan's funding, in fact, represents only about 8 percent of the expected $1 trillion in residential mortgage losses, according to projections by Goldman Sachs. (That figure doesn’t include losses on mortgages owned or sold by government mortgage giants Fannie Mae and Freddie Mac.)

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