For those of us that pay attention to the world of home loan workouts there was a great deal of anticipation leading up to President Obama’s speech today. The President’s 75 billion dollar plan is estimated to help as many as 5 million homeowners. However, it will not help all homeowners. In addition, details of the plan have been reported by virtually every media outlet and the details they each provide are inconsistent.
In my own experience writing blogs I have come to realize something extremely important, namely, that media outlets publish a wide range of “facts” regarding major financial news. While the purpose of the media is supposedly to provide for an informed public, wide variations of so called “facts” only make it harder for the public to receive accurate information. The purpose of this post, then, is to provide my public with a detailed explanation of the new plan, expose some of the inconsistencies in media supplied information and give you, my audience, the best possible source of information regarding the plan so you can best benefit from the sweeping changes announced today.
With the task of explaining broad ranging economic policy I feel it is best to first ask three questions that I know millions of people are asking. (1) Who will benefit from the new plan? (2) Who won’t benefit from the new plan? (3) What are the specific details of the plan?
Who Will Benefit from the Plan?
“The plan I am announcing focuses on rescuing families who have played by the rules and acted responsibly: by refinancing loans for millions of families in traditional mortgages who are underwater or close to it.” – President Barack Obama
The new plan will help two categories of homeowners as well as Fannie Mae and Freddie Mac. The homeowners this plan will help fall in to two categories. First, homeowners that are in distress and at risk of foreclosure will benefit from the plan. Second, homeowners that are current on their mortgage with high interest rates and with little to no equity would also benefit. Lastly, Fannie and Freddie will receive a capital injection of 200 billion from the Treasury department to increase the amount of available credit. While capital injections from the Treasury to Fannie and Freddie are not new, help to homeowners that are not at risk of foreclosure is a substantial departure from the economic policies of the Bush administration.
Who Won’t Benefit from the Plan?
This plan “…will not rescue the unscrupulous or irresponsible by throwing good taxpayer money after bad loans.”– President Barack Obama
While details of the new plan are clear in that speculators will not receive aid, non-speculators in owner occupied homes may not benefit either. So, there is one specific category that will not benefit and another category of homeowner, more difficult to describe, that won’t benefit either. Here’s an easy way to understand if you won’t benefit: (1) if you are trying to either save a non-owner occupied home from foreclosure or you want to benefit from newly introduced government backed refinancing guidelines you’re just out of luck. And if (2) you are in an owner occupied home and you can’t afford the home due to job loss or complete inability to pay, lenders will not be forced to help nor will the government come to your aid.
What are the Specific Details of the Plan?
The new program will roll out on March 4th, 2009 and complete details of the plan will be available at that time. Obama’s new plan focuses on three critical needs. First, the need to incentivize lenders to modify loans for distressed borrowers. Second, the need to provide refinance options for homeowners that are current but with homes that have little to negative equity and finally, to increase the amount of available credit.
On the need to incentivize lenders to provide loan modifications:
Obama’s plan is voluntary for mortgage servicers except for Fannie Mae and Freddie Mac and banks that accept help from the government. These institutions must adopt loan modification plans. The loan modification plan is for primary residences only and will benefit borrowers with higher rates, adjustable rates and interest only loans. The plan, however, will not reduce the principle loan balance.
The servicer would reduce interest rates so that the monthly obligation is no more than 38% of a borrower’s income and then the government would contribute money to bring payments down to 31% of the homeowner’s income. Servicers can also reduce the loan balance to achieve these affordability levels. The government will share in the cost, up to the amount the servicer would have received if it had reduced the interest rates.
Homeowners with a total debt ratio equaling 55% of their monthly income must enter a debt counseling program to qualify for a modification.
Because loan modifications are more likely to succeed if they are made before a borrower misses a payment, the plan will include households at risk of imminent default despite being current on their mortgage payments.
The Homeowner Stability Initiative has a simple goal: reduce the amount homeowners owe per month to sustainable levels. Using money allocated under the Financial Stability Plan and the full strength of Fannie Mae and Freddie Mac, this program has several key components:
- No Aid for Speculators: This initiative will go solely to helping homeowners who commit to make payments to stay in their home – it will not aid speculators or house flippers.
- A Shared Effort to Reduce Monthly Payments: For a sample household with payments adding up to 43 percent of their monthly income, the lender would first be responsible for bringing down interest rates so that the borrower’s monthly mortgage payment is no more than 38 percent of their income. Next, the initiative would match further reductions in interest payments dollar-for-dollar with the lender to bring that ratio down to 31 percent. If that borrower had a $220,000 mortgage, that could mean a reduction in monthly payments by over $400. This lower interest rate must be kept in place for five years, after which it could gradually be stepped up to the conforming loan rate in place at the time of the modification. Lenders will also be able to bring down monthly payments by reducing the principal owed on the mortgage, with Treasury sharing in the costs.
- “Pay for Success” Incentives to Servicers: Servicers will receive an up-front fee of $1,000 for each eligible modification meeting guidelines established under this initiative. They will also receive “pay for success” fees – awarded monthly as long as the borrower stays current on the loan – of up to $1,000 each year for three years.
- Incentives to Help Borrowers Stay Current: To provide an extra incentive for borrowers to keep paying on time, the initiative will provide a monthly balance reduction payment that goes straight towards reducing the principal balance of the mortgage loan. As long as a borrower stays current on his or her loan, he or she can get up to $1,000 each year for five years.
- Reaching Borrowers Early: To keep lenders focused on reaching borrowers who are trying their best to stay current on their mortgages, an incentive payment of $500 will be paid to servicers, and an incentive payment of $1,500 will be paid to mortgage holders, if they modify at-risk loans before the borrower falls behind.
- Home Price Decline Reserve Payments: To encourage lenders to modify more mortgages and enable more families to keep their homes, the Administration — together with the FDIC — has developed an innovative partial guarantee initiative. The insurance fund – to be created by the Treasury Department at a size of up to $10 billion – will be designed to discourage lenders from opting to foreclose on mortgages that could be viable now out of fear that home prices will fall even further later on. Holders of mortgages modified under the program would be provided with an additional insurance payment on each modified loan, linked to declines in the home price index.
- Institute Clear and Consistent Guidelines for Loan Modifications: Treasury will develop uniform guidance for loan modifications across the mortgage industry, working closely with the bank agencies and building on the FDIC’s pioneering work. The Guidelines will be used for the Administration’s new foreclosure prevention plan. Moreover, all financial institutions receiving Financial Stability Plan financial assistance going forward will be required to implement loan modification plans consistent with Treasury Guidance. Fannie Mae and Freddie Mac will use these guidelines for loans that they own or guarantee, and the Administration will work with regulators and other federal and state agencies to implement these guidelines across the entire mortgage market. The agencies will seek to apply these guidelines when permissible and appropriate to all loans owned or guaranteed by the federal government, including those owned or guaranteed by Ginnie Mae, the Federal Housing Administration, Treasury, the Federal Reserve, the FDIC, Veterans’ Affairs and the Department of Agriculture.
On the need to provide refinance options for responsible borrowers:
Those who are current on their payments and whose loans are held or guaranteed by Fannie Mae and Freddie Mac are eligible. The plan would help borrowers who owe more than 80% of their home’s value to refinance and reduce their monthly payments. However, the new mortgage, including refinancing costs, can’t exceed 105% of the current market value of the property. So if your mortgage is $210,000, your property can’t be worth less than $200,000. Borrowers with a second mortgage are eligible as long as their first mortgage isn’t more than 105 percent of their home’s value. The value of your property will be determined after you apply to refinance. The government backed refinance program allows borrowers to refinance into 15-year or 30-year fixed-rate mortgage at prevailing market rates, currently hovering around 5.00%
Increasing the amount of available credit:
Like the Bush administration’s economic stimulus plan, Obama’s new plan will provide more capital to Fannie Mae and Freddie Mac. While the last stimulus package provided 100 billion in aid to the mortgage giants, Obama will double the figure to 200 billion. This plan has two primary goals. The first and most obvious goal is to significantly add to the amount of available credit. Second, and less obvious, this new injection of capital will allow Fannie Mae and Freddie Mac to expand the size and scope of their mortgage portfolios, perhaps as a safety valve for banks on the brink of insolvency.
For struggling homeowners, the most important idea to take away from this plan is that lenders and servicers are not required to participate in loan modification programs. Participation is voluntary. On the surface, this may seem like a policy without any teeth. However, lenders and servicers will be incentivized with government handouts to do the right thing for homeowners.
Motivating mortgage servicers to work with homeowners is the basis of the plan. The government will pay servicers $1,000 for loan modifications and an extra $500 for mortgages modified before the borrower misses a payment. Additional incentives for mortgage servicers are included in the “pay for success” provision of the plan which pays servicers up to $3,000 over three years if the borrower successfully makes payments on the modified loan during the same period.
You as a homeowner may be asking yourself, “What’s the benefit of giving my mortgage servicer my tax dollars to help me save my home?” Actually, it will do a whole lot of good because now mortgage servicers can recoup fees and possibly make money by helping you with a loan modification. Before the plan, servicers would receive fees when one of the homes they serviced went in to foreclosure. Now, servicers have a monetary incentive to not allow your home to go in to foreclosure. Without such payments servicers might continue to foreclose on securitized mortgages even when foreclosure is not in the interests of borrowers and lenders. These monetary incentives are the key to the Obama plan. Moreover, these incentives set this new plan apart from past attempts to stem the tide of foreclosures.
Another critical aspect of this plan to keep in mind is that the loan modification program will not guarantee a reduction of your mortgage balance. But, again, lenders will be incentivized to do so. The Treasury will share the cost when lenders reduce monthly payments by forgiving a portion of the borrower’s mortgage balance, the government said. In addition, the average borrower’s home value could be stabilized against a price decline by up to $6,000, according to the White House fact sheet. So, if the government can incentivize loan modifications, if they can incentivize servicers to not foreclose on homes and if they can incentivize limited principle reductions, then why can’t they guarantee principle reductions for borrowers hardest hit by housing market declines? The answer is simple, guaranteeing principle reductions will be a “prohibitively expensive proposition” according to Glaser, a mortgage industry analyst.
Focusing on the shortcomings of the plan belies the tremendous benefit this plan will have for the millions of struggling homeowners. In addition to the government incentives for doing the right thing by the suffering homeowner, this plan will also establish clear guidelines for loan modifications. Universal modification guidelines could not have come sooner as thousands of Americans have been victimized by fraudulent and unscrupulous “foreclosure consultants.”
I’d like to close this important post with a quote from Walter Lippmann, journalist, media critic and philosopher:
“Unless the reformer can invent something which substitutes attractive virtues for attractive vices, he will fail.”
I honestly feel President Obama is trying his best to improve the foreclosure crisis with this program. It seems to me President Obama is incentivizing the attractive virtue of helping the American homeowner with this plan and I will continue to serve this cause with every ounce of my effort.