The Great Mortgage Modification Pump – GOD SAVE US ALL!

Posted on November 19th, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

As you all know, this is a hot topic for me.  All of these proactive loan modification efforts now coming out of the woodwork by every bank, regulator and government agency is destined to keep the housing market completely depressed and turn home owners trapped renters, unable to sell or refinance, for decades. Why in the world would any home owner want to go this route?

It is obvious why the institutions are pushing for this. They are rushing out with modification plans because higher paper grades are now defaulting at a staggering rate due to negative equity and home owners finding it better to walk away from all that debt and rent.

What’s worse is that over the past five years there was a fundamental shift of how people viewed their home – from ‘a place to live’ to their single ‘largest investment’.How could they not when all loan programs from Subprime to Prime allowed 50% of gross income (greater when considering limited income doc loans) to be used towards debt. In the good ‘ol days when housing was viewed as a place to live financing was sound with down payments required and no more than 28% of gross income going towards housing debt. 50% debt-to-income ratios changed the game.

Make no mistake about it – MOST BORROWERS ARE NOT WALKING BECAUSE THE CAN’T AFFORD THE PAYMENTS. They are walking because all of their after-tax income each month is going out in bills and the largest portion is going to a home worth half of what they owe. When they are spending such a large portion of their income on a massively depreciating asset, it makes good financial sense to dump that asset. When you can’t sell, that means walk away.

50% debt-to-income ratios means that most after-tax income is going out each month to pay bills with the house payment being the largest piece.  This is a tough nut to swallow when your house is down 50% in value and you are 30% upside down in your mortgage…yes, these are 20% down prime borrowers I am talking about.  This makes the decision to walk all the easier. The easiest and quickest way for the underwater, over-leveraged home owner to stop the pain is to walk.  The new modification plans are designed to make that less attractive by playing the ‘low monthly payment’ game.

That being said, there are many who can’t afford their payments because of an ARM adjustment. But at one time they were qualified by the bank and given the way the loan was structured they could in fact afford the loan.  Banks and Realtors in every city in the nation used high-leverage, exotic loans in order get people to qualify for ever increasing loan amounts. By 2005, interest only was industry standard, so was stated income. But lenders didn’t worry what happened to the loan after a few months because the loan was sold and they lose all liability.  The 2/28 Subprime ARM was a perfect example of a loan program not designed to hold over the initial teaser period and one the lender didn’t care about because most were sold and securitized.

But even the securities investors never planned on holding these long. 2/28’s and alike were always meant to be temporary loans.  Exotic loans with teasers were sold as a ‘way to get into the home more cheaply’ or a ‘way to improve your credit then refi into something better a couple of years from now’.  This philosophy was not isolated to Subprime 2/28’s either – Prime 5/1 interest only ARMs and Pay Option ARMs were also sold the same way.

I have been telling all of you for a long time that banks will have to MODIFY EVERY LOAN made between the bubble years of 2003-2007 in order to fix this problem, but I never dreamed they would do it this way.  Reworking loans to make ‘payments affordable’ without permanently reducing principal balances is the worst possible thing that can be done because it ensures the housing and foreclosure crisis will be with us for a long time. If these programs are widely accepted, housing is a dead asset class indefinitely.

However, they are accomplishing one thing by keeping borrowers leveraged-up, paying low monthly payments and adding all of that deferred interest and payments to the back of the loan – that’s bailing out the banks.

This style of modification does not sit well with owners of mortgage securities either, which make up the bulk of distressed mortgages. This is because deferred interest, 40-year terms and interest only teaser periods greatly reduces the cash flows and lengthens the duration of the security.  For many securities owners, its better to have the home sold in foreclosure so they can recoup at least part of their investment. Again, the new plans only help the banks and the whole loans they own. These plans allow the bank to avoid a write down – the banks get their money cheap enough to offer 1.5% and still make money.

Homeowners – SMARTEN UP!The FDIC program keeps you fully in debt, renting your home for the rest of your life. This is a terrible solution. This is no different than other programs being offered by banks such as Chase, BofA and Wachovia. Why in the world would a sensible person accept such a program?

WITHOUT A PERMANENT PRINCIPAL BALANCE REDUCTION, NO MORTGAGE MODIFICATION PROGRAM WILL EVER WORK. Period…end of story.

If you walk away now your credit will be ruined for 5-10 years. So what. It will take much longer than that for home prices to ‘come back’.  It will take even longer for borrowers to pay off the original mortgage loan amount, which could be 100% higher than the present value of the property. And if borrowers accept this they will have to pay down the loan because you are upside down and can’t sell!

Think about it folks!  If your home value is down or you are underwater by 50%, which is not too bad especially is many areas in the bubble states, YOUR VALUE HAS TO GO UP 100% for you to break even or for your home price to ‘come back’. Quit dreaming. It ain’t gonna happen.

If house prices stopped going down this very minute and started rising at a historical 5%-7% per year based upon a good overall economy, low interest rates, strong sentiment and rental rates it would take years for prices to get back to where they were. And we don’t have a good economy, low mortgage rates, strong sentiment or rising rental rates.

These mortgage modification efforts only lower monthly payments. They are no better than the toxic loans that caused all of this mess in the first place. They only kick the can down the road. They rely upon ‘extend terms to 40-years, deferred interest and low introductory rates’. THIS IS HOW WE GOT HERE IN THE FIRST PLACE – they were called ‘2/28s’, ‘interest only’ and ‘Pay Option ARMs’.

What they are trying to do is simple – play with monthly payments so borrowers find it easier to stay than walk away and rent.  IT IS A TRICK, just like when the car salesman asks ‘how much can you afford to pay each month?‘  Then the payment comes in low but your term is 84 months.  You never end up getting right side up.  As a society we need to break the ‘monthly payment’ habit and get back to reality which is saving money and spending less.

The fact is when you accept this type of modification YOU ARE RENTING. It is WORSE THAN RENTING because when you walk away and rent you don’t have the debt any longer. With these new mortgage modification programs, all of the debt stays with you forever.  What happens down the road when you do lose your job, become ill or are having a rough time meeting your obligations – you walk because you are upside down and you have no skin in the game.  What motivation are you going to have to spend money maintaining the property? Five years from now you will be able to drive down any street and pick out the homes with an FDIC modification – they will be the ones with overgrown yards, broken fences and faded paint.

AMERICA DESERVES PRINCIPAL BALANCE REDUCTIONS – YOU WERE DECEIVED. GET IT?!?

It is time for the banks to write down principal.

The greatest real estate bubble of all time was only able to occur because of the bank’s allowing home owners to use extraordinary leverage created through exotic loan programs and easy credit that never existed before and never will again.

From 2003 through 2007 everyone made $150k a year for the purposes of buying a home. Home prices responded by surging higher to meet the new found nationally high affordability level.

Banks did not care about the structure or long-term viability of the loans because most were sold and securitized shortly after funding. Typically after six months, the originating or securitizing lender has no more responsibility for the outcome. Therefore, who cares about creating loans that will last – just make loans that will last at least six months.

Everyone was suckered, as these loan programs became the norm. Folks who really earned $150k a year went out and bought over priced homes based upon flawed and temporary fundamentals not knowing they were being suckered.  Now they too are upside down in their home by 50% and have seen their life savings go up in smoke.  They overpaid because the janitor was bidding against them using a stated income 100% interest only combo.  Hey, the loan officer at the bank and the Realtor told the janitor that ‘based upon his income and credit you qualify for this loan’.  Why should he argue with his bank? They know best. They are the experts.

But now it is obvious that the past six years was an illusion and none of those easy credit, high-leverage programs exist any longer.  Prices are coming down to the real affordability levels using 15 and 30-year fixed rate loans and a down payment, which has rendered the nations financial institutions and millions of home owners instantly insolvent. The same household that earns $75k per year that two years ago could buy a $650k home with no money down can now buy a $275k home with 10% down.  It now takes at least $150k a year and a large down payment to buy a $650k home.

100% stated interest only and Pay option ARMs will not return.  Nor will 100% HELOCs. They were doomed to fail from their creation. The banks had modeling systems that they never stress tested.  You mean to tell me that it never occurred to the smartest guys in the room to plug into the model that home prices could actually fall? That was a fatal error that the world is paying for. But the banks will never pay if everyone gets an FDIC or bank designed mortgage modification because they make the borrower take 100% of the hit.

Yes, there were people who took advantage of the system. But, that was a small percentage of everyone who bought a home on flawed and temporary market fundamentals induced by easy credit and exotic loan programs that never should have existed in the first place. This five year period of absolute recklessness and blind greed on the bank’s part was the real driver of home prices. Taking that away is ‘going straight’ is the leading driver for the destruction of the housing market and consumer.

THE SOLUTION

If not for the unregulated institutions providing unlimited and irresponsible credit and leverage to every household in America this never would have happened.

First off, I am a fan of letting the market work and the housing/foreclosure crisis clearing itself up on its own. We are already seeing positive signs that the Subprime crisis is on the other side of the hill mostly on its own. The problem is that the Alt-A, Jumbo Prime and Prime mountains lie ahead. However, if the government and banks are hell bent on modifications, I am going to use whatever voice I have to try to convince as many as possible to do it the right way.

This blame does mostly lie with the banks, law makers, and regulators (including Greenspan) who branded and endorsed these loans as mainstream until 80% of all loans in the state of CA in 2006 were exotic by definition. This is very similar to the cigarette makers not telling the American consumer for decades that Cigarettes were highly addictive and cause cancer. They were branded as the ‘cool thing to do’ and then lied about the health effects and addictive qualities in nicotine for two decades until science caught up.

To fix the housing market and greatly aid the economy you must focus on two important segments that made up 80% of all housing activity – the refinancer and move-up buyer. Now they are the minority. This is a major problem. We need to get these people back into the market.  Investors, vacation home buyers, renters and first-time home buyers have always been the smallest segments of the market and now they its primary participants.  The may be great for low priced homes in foreclosure epicenters, but as the problem jumps tracks into Alt-A, Jumbo Prime and Prime, higher end areas will follow down the same path. Without any reasonable financing available for loans over $417k, it is already a foregone conclusion.

Prices are coming down fast and the market will clear at some point and at some level. But that level could be years away.  The banks, regulators and lawmakers with all of their terrible loan modification plans will ensure it takes two decades for this to happen.  See ‘The Great Loan Modification Pump- God Save Us All! for the reason why.  Recidivism rate after loan mod is 50% because most loan mods keep the borrowers levered up and underwater in their homes. The plans by FDIC, banks and lawmakers do exactly this. My plan will achieve the same within a couple of years. Yes, there will be pain but much less. As with the financial institutions, the quicker the borrowers de-lever and raise cash the better for the housing market and economy in general.

It is time for the very same financial institutions that created all of this to do what’s right and re-underwrite every loan originated between 2003 – 2007 using prudent underwriting guidelines. Then, they must reduce the principal balance to what the borrower really earns using a 28% housing and 36% total debt-to-income ratio at a market rate 30-year fixed loan. When home owners are levered at 28/36 they are able to save money and live a decent lifestyle. If they go upside down in their property who cares – they are still able to save money. At 28/36, their home once again becomes a place to live.

If reducing the principal balance to 28/36 on a market rate 30-year fixed loan is $100k lower than the present value of the home, the bank can take can take the differential through a second mortgage or equity warrant.  if the borrower sells or walks away then, the banks gets paid. But the home owner gets all of the upside. If the borrowers can’t prove income, then they need to leave the house and rent.  They should have been renters all along. Anything less and the program will fail.

This will not prevent housing prices from coming down substantially over the next few years especially considering the massive multi-year foreclosure overhang, gross amount of negative equity across all paper grades and terrible mortgage modifications that the banks and regulatory agencies are now trying to push.  But at least it would be the best way to begin to undo the irresponsibility of the past five years and get back to basics where prices are based primarily on traditional factors such as incomes, interest rates, macroeconomic conditions, sentiment and rental rates.  – Best, Mr Mortgage

AN ALTERNATIVE PLAN by CR Harrington

Here is my solution to our problem…  Give homeowners who are in default on their mortgages, $1000 from the treasury to be payable directly to an attorney who understands predatory lending. If the mortgage closing paperwork audit reveals any violation of Respa, TILA, etc, and further identifies any potential lending violations, especially on exotic mortgages (option ARM, Alt A, Interest only, Neg am, etc.) then allow an additional $9000 flat fee to the attorney to SUE the bank for fraudulent business practices, deceptive loan practices, concealment, theft by deception, whatever…. What if 70% of all loans between 2003-2007 were illegal? What if the banks don’t even own the loans beyond servicing, and the true holder of the note has imploded? Give the homeowners a year in the house during the lawsuit (to save up some money and keep one less house on the market) and then give the homeowners who win their homes in successful lawsuits, a free house – free and clear. Then they can sell their home for 50 – 60 (market value?) cents on the dollar to pay off their credit card bills and whatever is left over can be a sizable down payment on an owner financed home. Also, keep $10,000 at closing to pay back the Treasury to recycle back into the DISTRESSED HOMEOWNER LEGAL BAILOUT FUND!!! Home values will stabilize – (its a start….,) more money from home sales gets put back into the economy, everybody wins (except the criminals on Wall Street and defrauded investors who are going to sue anyways – they then can win and get the leftover homes that weren’t contested.) This is “trickle-up” and makes for a common sense solution that does not burden the tax-payer – very much.

More Mr Mortgage & Mortgage Modifications

251 Responses to “The Great Mortgage Modification Pump – GOD SAVE US ALL!”

  1. My plan would be to have a principle only moritorium.
    This would last between 3 to 5 year and would allow people to pay down on their principle to get it to more affordable levels. Then after that period they should be allowed to lock in on a 15 or 30 year fixed low interest
    loan.

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