Last week, President Barack Obama unveiled a comprehensive plan to address the housing crisis and help the millions of families who have been hit by recession. The $75-billion plan is designed to reduce foreclosures through refinancing, loan modification, and other forms of assistance.
Experts are still divided on whether this plan is another band-aid solution, or will actually work for the long term. But one thing's for sure: if your mortgage has put you in a financial rut, Obama's housing plan can give you the leverage you need to get back on track. Here's a rundown of the President's plans and what they mean for you as a homeowner.
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State-backed refinance
Under the planned refinancing scheme, borrowers who currently have conforming loans can get them refinanced to better terms through their current lenders. Depending on your qualifications, your lender can offer you a Fannie Mae or Freddie Mac-backed loan with a lower interest rate. Key requirements include occupancy (you must reside in the property) and proof of household income.
But how does it really help? The benefits of this new refinancing program are geared towards people whose homes have depreciated, or declined in value. This makes them ineligible for regular refinancing, as they don't have enough equity to make the loan worth it. With Obama's refinancing plan, people with little or even no equity can qualify for a refinance and better afford their homes.
Reward systems
If you've weathered the crisis and kept your mortgage up to date, can you still benefit from the program? Definitely-the plan is designed to reward timely borrowers by giving them access to even better financing terms. This way, refinancing best fits those who made reasonable choices and stuck to them. It also reduces the likelihood of a timely borrower walking away from a bad mortgage, and keeps the collective value of community housing from collapsing due to foreclosures.
Loan modifications
Loan modification rose to prominence last year as a promising fix for people in deep financial crisis. It allows the borrower, usually backed by a loan modification attorney, to negotiate better terms with the bank so that he or she can better afford the payments. Millions of loan modifications were granted last year, but the lax terms meant that delinquent borrowers would remain delinquent after a loan modification, often resulting in second defaults (and even bigger losses for the lenders).
The new program will restrict loan modifications so that only at-risk borrowers-officially, those who spend more than 38% of their income on mortgage payments-can qualify for assistance. The program gives lenders the option to either reduce the principal or lower the interest rate, so that it meets the 38% debt-to-income ratio. The government will split the additional cost with the lender, further reducing the payments to a comfortable 31%.
Bankruptcy
The program will also boost previous measures to allow bankruptcy loan modifications. Under this plan, bankruptcy courts can modify mortgage loans on properties used as primary residences. This means that people who are in or nearing bankruptcy can qualify for standard loan modifications, including principal reductions.
Loan modification firms and bankruptcy mods
The new provision will naturally result in a surge of bankruptcy loan modification applications. Loan modification firms may take a while to integrate the changes into their programs. If you're thinking of trying your luck, you may have a long wait ahead of you-although there are ways to speed up the process.
Excessive Debts Causing Post-Modification Defaults
Homeowners who get loan modifications may be too quick to get back on the spending track, putting them at risk for second defaults. Residential Capital, LLC, one of the country's leading mortgage servicers, reports that almost half of the loan modifications they granted last year went back into default after less than six months. This has raised the question of whether loan modifications can really prevent foreclosure, or just hold them off temporarily.
Excessive credit
At last week's meeting with the American Securitization Forum, ResCap CEO Thomas Marano reported that excessive credit was the main reason for most second defaults. According to Marano, once people get their mortgage modifications, many immediately use their savings to load up on other debt (such as credit cards). He adds that the rise in unemployment, resulting from large-scale cost-cutting by major companies, is also working against loan modification programs.
Debt counseling
Marano says that borrowers need to see loan modification as a long-term commitment rather than a one-off solution to mortgage problems. To do this, he recommends putting borrowers through debt counseling as part of the loan modification program. This will help them make smarter decisions on future credit, particularly on credit card spending.
The move will also benefit credit card companies, who are already starting to feel the crunch from missed and late payments. Last week, Fitch Ratings reported that delinquencies in consumer credit hit a record high in the past month-a figure that's expected to rise if the current loan modification programs aren't adjusted.
Qualification adjustments
The general requirement for a loan modification is a debt-to-income ratio of about 35%; that is, the mortgage payments must take up no more than 35% of a borrower's income. According to Marano, however, this figure often exceeds 60% when other debts are taken into account. Working together, these debts virtually ensure a second default, even when the mortgage is significantly modified.
Government support
The government has long supported loan modification as a promising solution to the real estate slowdown, which has been further fueled by recession. However, implementing the program has proven difficult as servicers find it hard to reach out to borrowers. Also working against servicers is their contractual obligation to match their investors' financial interests with those of their borrowers.
This is why many mortgage servicers, including ResCap, have teamed up with the Federal Housing Finance Agency (FHFA) to boost foreclosure prevention. FHFA director James Lockhart added that the agency plans to help servicers whose profits have drastically declined due to delinquent mortgages.
Principal reduction
Among the measures being taken to expand modification programs is principal forbearance-a permanent reduction of the principal balance on homes that have lost their value. However, Marano says, this may result in moral hazards since many homeowners consider their homes an investment. ResCap is currently working out a "shared appreciation" system wherein the servicer (or its investors) can mutually recover losses from such modifications.
Homeowners' options
Loan modifications continue to be one of the most viable solutions to mortgage problems. The key for struggling homeowners is to make the right choices both before and after the change, and to work with the right professionals. Attorney-backed real estate licensed loan modification companies can offer sound advice on choosing a loan modification plan and staying on track afterwards.
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