Late Thursday, it leaked that the Obama administration is planning to broaden its foreclosure prevent program. The details, however, remain somewhat unclear. At this point, we know the new initiatives will include principal reduction and payment deferrals to help Americans who are unemployed, underwater or have second liens avoid foreclosure. When the details are revealed on Friday, here are some questions to ask:
How will payments be deferred or shrunk for the unemployed?
For quite a while now, the subprime mortgages haven't been the big problem: unemployment has. Even if you're a prime borrower, it can be hard to pay your mortgage if you lose your income. From what we know, the Treasury will allow some unemployed Americans to defer or shrink their monthly payments for several months.
Will the government be footing the bill for these altered payments or have banks agreed to temporarily defer or shrink them? Obviously, the latter would be fantastic news for both borrowers and taxpayers. Also, what if the borrower still doesn't have a job once the deferral period expires?
How much funding will be provided for principal reductions on underwater mortgages?*
The median home price for existing homes is $165,100, according to the National Association of Realtors. Let's say the average struggling underwater borrower has a loan-to-value ratio of 130%, which isn't outlandish. If you use that average home price and the 115% LTV the program will use, then the underwater borrowers will have a mortgage of about $215,000 reduced to $190,000. So the banks will have to post a $25,000 loss per modification. The government will need to make it worth their while to reduce principal and take the associated losses immediately. They may want to cover at least 20%, which would be $5,000.
If the Obama administration is putting aside $14 billion (as reported), then up to 2.8 million could be modified, under the above assumptions. Of course, if the payment to banks or the number the Treasury hopes to help is higher, so is the cost.
How will they more effectively encourage the modification of second liens?
According to the Washington Post's source, the new program will double the amount the government pays to lenders that help modify second mortgages. I'm a bit unclear if this means the servicers or the lenders/investors. I'm guessing they mean the latter, because a servicer probably need less incentive. Again these lenders/investors will need to be compensated well to withstand the losses that will result from writing off the second liens immediately, instead of waiting for foreclosures to take place.
What are the carrots/sticks in place?
Will the Treasury force servicers who are participating in the HAMP program to comply with these new initiatives? If this is significantly more aggressive than HAMP -- and it may be -- then lenders may put up a fight. There's a reason why, up to now, most haven't offered many principal reductions on first and second mortgages or provided unemployed borrowers with deferrals. They don't want the immediate losses. So either the Treasury needs to find a way to coerce lenders to go along with these changes or offer them better rewards to comply.
Could it cost taxpayers more?
The Post also says that the Federal Housing Administration (FHA) will be involved. I'm a little unclear why. It could be that the Treasury hopes to encourage lenders to take part in these new initiatives by slapping a government guarantee on the modified mortgages through the FHA. While most of the carrots would be paid by the $50 billion in bank bailout money already set aside for modifications, I'm not as convinced losses from FHA guaranteed re-defaults would utilize this funding. If they those losses aren't covered, then taxpayers could end up footing the bill for any FHA guaranteed re-defaults. And unless the principal reductions are extremely aggressive and unemployment declines rather quickly, re-default rates could be very, very high.
*Edited the numbers here shortly after posting, after seeing Reuters' report (which they claim beat the Post's) that the underwater mortgages will be reduced down to 115% LTV and $14 billion would be spent.