Sheila Bair’s underwriting makes Angelo Mozillo’s look tight. The IndyMac loan modification shown here has redefined ‘exotic’ and ‘leverage’ with respect to mortgages. I am going to name it the 5-year hybrid, 30-year term, 8-year graduated payment, 176% combined loan-to-value, mega-balloon, super bendover ARM (document below). And you thought Pay Option ARMs were exotic!
Even IndyMac has a extraordinarily long acronym for this modification. The image below is cut straight from the document. Breaking out the acronym using mortgage lingo you get: Bulk Modification Principal & Interest and Interest Only Fixed and Adjustable Rate Mortgage with Step-Term Balloon. It is this very ‘innovation’ that got us here in the first place.
If they would have had these loans out during the bubble years the housing bubble could have grown twice as large.
This borrower is not as bad off as many in the bubble states – they are only 44% or $370k underwater in their home. Their present first mortgage is only slightly higher than the value of $475k. But when you add in the $345k second mortgage that the IndyMac modification lets stay in place, they are $370k upside down.
This modification makes the borrower a renter and debt-prisoner for life. This is not a financial solution for the borrower, rather a structure that lures the borrower into a terrible financial decision because it is cheaper to stay than walk away and rent. All of these new proactive loan modification plans by the law makers, regulators and bank are designed to do just this. A ‘solution’ where the borrower still owes $840k on a $475k home and will never be able to refi or sell, should send them running.
While some will take this offer, I am hopeful that the typical home owner is not this ignorant. That is a lot of debt to carry around for life. On the other hand when you have nothing to lose and your only alternative will be foreclosure 6 months down the road, you may just accept the offer not considering the legal ramifications. I am sure this is also what the banks hope.
One thing is for sure – having millions of zombie homeowners unable to refi or sell their property awaiting the day a life circumstance forces their default and foreclosure is not the clearing process needed for an ultimate bottom in housing. Modifications such as this stretch the problem out several years.
I do believe that Sheila Bair is doing all that she can with the tools provided to her and banks that refuse to modify loans using principal balance reductions.
Let’s be clear – I am all about letting the housing markets clear naturally. That is the only way we can be sure when we hit a real bottom. But the solons are hell bent on modifying there may out of this and they are on the wrong track.
I am in firm belief that the only successful mortgage modification is one where the loan is re-underwritten / restructured using a market-rate 30-year fixed mortgage at 28/36% debt-to-income ratios. To get there, a principal balance reduction will likely be necessary in most cases. But the process will allow home-owners to operate at leverage ratios that greatly reduce the chances of walking away due to negative-equity permanently solving the problem.
A year from now when the after-modification 50% mortgage default recidivism rate keeps growing they will do mods the right way. But between now and then hundreds of thousands of home owners could sign their lives away. It is a shame.
Please see my most recent report on mortgage modifications and the right solution:
- The Great Mortgage Modification Pump – GOD SAVE US ALL! (248)
Posted on November 19, 2008 12:01 PM
New IndyMac Loan Mod Structure & Term
New first mortgage: $494k
Second mortgage in place: $345k
Total liens: $840k
Combined Loan-to-Value: 176%
Negative Equity: 44% ($370k)
Interest rate: First 5-years at 3%
Graduated rate/payments: Years 6-8
Max rate: 6.25%
Balloon (deferred principal): $245,581 (even at 3% this borrower could only legitimately qualify for roughly a $250k loan.)
The actual numbers have been changed slightly to protect the borrower. They are in exact proportions to the original loan modification.