Will the Obama plan reduce foreclosures

A new deal from Washington that potentially will allow millions of homeowners to lower their monthly mortgage costs and avoid foreclosure was unveiled last month by President Barack Obama.

“With $75 billion set aside to help individual homeowners, the Obama Administration's Homeowner Affordability and Stability Plan is designed to slow or even reverse the foreclosure tide by helping three to four million borrowers who are now in danger of losing their homes,” says Jim Saccacio, chairman and CEO at RealtyTrac.com, the nation's leading online marketplace for foreclosure data and listings. “No less important, the plan is also intended to assist those who are actually current on their mortgages but upside down on their properties; that is, owners with a mortgage balance that exceeds the property's value.

“Will the plan work?” asks Saccacio. “Within the next few months we should have some hard numbers that tell us what has been done. If home prices merely begin to stabilize in many markets that would be one hopeful sign.”

Will the Obama plan really work? As we shall see there are both reasons for homeowners to be happy — and reasons to be dubious.

Underneath All

Essentially the Obama plan divides the world of mortgage borrowers into three basic groups:

• Those who are current but underwater. For borrowers in this category with loans owned by Fannie Mae and Freddie Mac, it will be possible to refinance even if the loan amount is marginally larger than the value of the home. For many borrowers this will mean moving from a toxic loan with high rates to a fixed-rate loan with a smaller interest cost. “Borrowers,” says the White House, “who are paying interest only, or who have a low introductory rate that will increase in the future, may not see their current payment go down if they refinance to a fixed rate.”

• Those who face foreclosure. The Obama Administration essentially adopts the early workout program developed by Fannie Mae. “In general,” says the White House, “you may qualify for a mortgage modification if (a) you occupy your house as your primary residence; (b) your monthly mortgage payment is greater than 31% of your monthly gross income; and (c) your loan is not large enough to exceed current Fannie Mae and Freddie Mac loan limits.”

• Those who are current on their loans and don't face foreclosure. Nope. No financial candy for you, at least directly. However, if fewer homes are foreclosed it means that home values are likely to stabilize and perhaps even rise — and that's good news for all homeowners.

How does the program really work? Let's look at some questions and answers.

What about the federal programs established in 2008 under the Bush Administration?

Both the FHASecure program and the Hope for Homeowners effort were total failures. Only about 4,100 delinquent conventional loans were refinanced under the FHASecure program before it ended on December 31, 2008. As of January 31, 2009, HUD had received 465 Hope for Homeowners applications — and approved none.

Can I get my loan amount reduced under the Obama Plan?

No.

Can I refinance an investment property under the Obama plan?

No.

How would the program actually work?

The Treasury Department offers this example:

“For a sample household with payments adding up to 43 percent of 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 his or her 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.

“That 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.”

In effect, the Obama Administration has dumped claims by banking and mortgage lobbyists that borrowers should be required to devote 38 percent of their gross income to housing costs. Instead, the Administration is going with the standard established by Sheila Bair, chair of the Federal Deposit Insurance Corporation, who for at least a year has been arguing that the 38 percent benchmark was unworkable.

Why should a borrower make their payments when so many cheaper homes are now available?

The Obama plan has an incentive for borrowers who stick with the program.

“To provide an extra incentive for borrowers to keep paying on time,” says the government, “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.”

Must the loan owner, the investor, participate in the Obama program and offer me a modification?

No. However, given the free-market alternatives many investors are likely to accept the Obama program.

If my loan is 20 percent greater than the value of the house can I still get a new loan?

No. As the White House explains “eligible loans will now include those where the new first mortgage (including any refinancing costs) will not exceed 105% of the current market value of the property. For example, if your property is worth $200,000 but you owe $210,000 or less you may qualify. The current value of your property will be determined after you apply to refinance.”

How much do I have to pay for a loan modification?

The White House says, “there is no cost to borrowers for a modification under the Homeowner Affordability and Stability Plan. If you wish to get assistance from a HUD-approved housing counseling agency or are referred to a counselor as a condition of the modification, you will not be charged a fee. Borrowers should beware of any organization that attempts to charge a fee for housing counseling or modification of a delinquent loan, especially if they require a fee in advance.”

I bought a smaller home, got a fixed-rate mortgage and make all my payments. Doesn't this plan actually reward those who were irresponsible?

No doubt a lot of homeowners are going to feel that way. The practical reality is that if you've been financially responsible you may suffer even more if the foreclosure mess is not resolved or limited.

I have a ton of credit card and auto debt. Will this plan help me?

Actually, yes.

The Treasury says that “borrowers with high total debt qualify, but only if they agree to enter HUD-certified consumer debt counseling. Specifically, homeowners with total “back end” debt (which includes not only housing debt, but other debt including car loans and credit card debt) equal to 55% or more of their income will be required to agree to enter a counseling program as a condition for a modification.”

Are you saying that some homeowners will get a mortgage subsidy from the government?

Indirectly, yes. For borrowers facing foreclosure, the way it works is that the lender will lower the interest rate until housing costs equal 38 percent of the borrower's gross monthly income. The government will then pay a subsidy to the lender, which will allow the borrower to pay the equivalent of 31 percent of his or her income.

The logic of this system is fairly plain. First, the lender will have to lower rates in many cases. Second, there is no sense requiring borrowers to pay 38 percent of their gross income for housing costs because such a standard merely results in massive numbers of re-defaults.

What if the lender doesn't agree to a lower rate?

The odds are pretty good that the lender will soon have a foreclosed property on their hands, something which typically results in $40,000 to $80,000 in losses.

Will banks and servicers cooperate?

We have essentially nationalized the banking system — just look at the major banks that have recently suspended foreclosures. The banks will cooperate and servicers, those who deal directly with borrowers for loan owners, will also cooperate, in part because there are substantial financial incentives for them in the Obama plan.

What are the potential problems with the Obama plan?

By any standard the Obama proposal is far better than anything from the federal government to date. That said, a number of concerns remain. For instance:

• Why exclude investors with single-family homes and properties with two to four units? The foreclosure of these properties can instantly drive down local property values. It doesn't help to label investors as “speculators” and “flippers.” How, exactly, is a real estate investor different from someone who invests in stocks and bonds?

• If unemployment levels continue to rise there could be a large number of foreclosures even with the program.

• Millions of people who have already lost their homes may well resent programs that were not available to them.

• The majority of mortgage borrowers, those who make their payments on time and in full, may also resent the program as it does not lower their loan costs. This is a potent political issue.

• Help is only available for those who are underwater a little — just 5 percent. This means that many borrowers will not qualify for modification assistance if their loans are materially underwater, something which could easily happen to millions of owners who bought in the past few years with little or nothing down.

The Obama plan is entirely different than anything tried by the federal government. The fact that such a plan could be developed within a month of the inauguration should be regarded as impressive, especially if the end result turns out to be a substantial reduction in foreclosure levels.

Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.