Under the terms of the historic $25 billion settlement announced last week, the country's largest mortgage servicers must pay $17 billion to distressed borrowers in the form of loan modifications, mostly through principal write-downs.
Painted as long-awaited redress for bank misdeeds, the penalty is supposed to funnel relief to the segment of homeowners hit hardest by the housing bust: "underwater" borrowers at risk of default.
But while the agreement appears poised to offer loan modifications to at least some distressed homeowners, details of the deal that have been released so far suggest that the assistance is not only extremely limited in scope but also, in the words of one expert, seemingly "arbitrary."
That's because, regardless of the standing of a loan, qualification for principal reduction appears to hinge on one question: "Who owns your mortgage?"
If the answer is "not a major bank," then there is a high probability that the borrower won't see a dime in assistance. That may strike some as unfair, says Jack Guttentag, an emeritus professor of finance at the University of Pennsylvania's Wharton School, because borrowers "don't have any say about who ends up owning their loan."
Loans owned by Fannie Mae or Freddie Mac, which account for half of the nation's mortgages, are already completely off-limits for write-downs under the deal, while FHA-insured loans, which also comprise a considerable portion of total market share, are also ineligible.
In addition, investor-owned loans which, like those owned by Fannie Mae or Freddie Mac, are packaged into securities, also generally fall outside of the deal's purview, according to the attorneys general. The North Carolina Department of Justice estimates that only 20 percent of modifications performed under the deal will touch private investor-owned loans.
Brace for Disappointment?
So what's left? Only relatively obscure loans that sit on banks' books, according Guy D. Cecala, CEO of Inside Mortgage Finance Publications Inc. "Most banks [don't] hold 30-year fixed-rate mortgages on their books," Cecala says, noting that mortgages owned by the five servicers account for just 7.3 percent of all U.S. mortgages.
The pool shrinks even further when you consider that most borrowers need to be at least underwater if not delinquent to qualify for principal reduction. Cecala estimates that just one in 10 bank-owned loans fits that mold. That would appear to leave less than one percent of American loans eligible for most of the modifications (excluding the relatively small amount of private investor-owned loans that stand to receive some relief from the deal).
Given those broad exclusions, many homeowners, who at first might think that they qualify for the deal, seem set up for disappointment.
That's certainly the case for Christy Mannering, who took out a 30-year, fixed-rate, zero-down mortgage for $189,000 from Countrywide (now owned by Bank of America) just prior to the housing bust. Mannering, who is a web designer at the University of Delaware and also runs the blog scrink.com, had always been under the impression that her servicer owned the loan. "Their name is all over everything," she says.
So when she and her husband heard of the settlement reached between attorneys general, Bank of America and other major servicers last week, the couple breathed a sigh of relief. With a home that's underwater by tens of thousands of dollars (according to Zillow, their house is worth $139,000, Mannering says), they believed that they were likely candidates for assistance under the terms of the deal.
But after a little research, Mannering discovered that they do not qualify because Bank of America sold their loan to what she calls a "phantom loan owner:" Fannie Mae. Unfortunately for the family, Fannie Mae-owned loans, are not eligible for modifications under the deal.
"I would have never thought that it is not [held by] Bank of America," Mannering said. "Bah, humbug."
Browse through photos of millions of home listings or search for rentals According to publisher Cecala, the mortgages that are most likely eligible for the relief are "legacy loans" from the go-go days of the housing boom: payment-option adjustable rate mortgages.
The loans offer artificially low "teaser rates" that exclude principal payment at first, but later "recast," often resulting in financial distress. The loans, which banks often keep on their books because they are too difficult to securitize, "became underwater very, very quickly," Cecala said, and the ones still limping along are likely to draw the attention of banks looking for ways to pay their share of the $17 billion penalty. But banks have already modified many of these loans, Cecala said, in order to keep them from defaulting. So only a fraction of them are still eligible for modifications.
A Possible Break for Jumbo and Second-Lien Loans
In addition, bank-owned jumbo loans, which are so big that they exceed the limit of what government-sponsored entities are usually allowed to underwrite, are likely candidates for the modifications. But they are generally healthy loans, since borrowers have always needed to meet relatively high standards to acquire them. That means only a small minority of these mortgages will qualify for write-downs as well.
Second liens, which banks tend to hold on their books, are another group of mortgages that could serve as fodder for banks looking to meet their modification quotas. But this option, mortgage experts say, is particularly unpalatable to lenders.
"There is incentive to do a larger principal reduction on the first lien, as it improves the position of the second lien," reads recent Amherst Securities Group L.P. report, which argues that banks are incentivized by the deal to modify private investor-owned mortgages in order to improve the standing of their second liens. (If a borrower receives a first-mortgage modification, then he is more likely to pay his second mortgage.)
The report also highlights the general incentive that banks have to use private investor-owned loans to pay their penalty credits: modifying a private investor-owned loan costs the bank almost zilch -- investors take the hit instead.
Contradicting the Amherst Security Group report's predictions, state attorneys general have said banks will not pass along most of their penalties from the deal to private investors. After all, they say, under the terms of the settlement, banks get fewer cents on the dollar for paying their penalty through private investor-owned loans, and may only modify those loans if their contracts with investors permit modifications. Cecala agrees, estimating that, out of all loans modified under the settlement, only 10 percent of them will be private investor-owned.
But Laurie Goodman, who co-authored the Amherst Securities Group report, told AOL Real Estate that she doesn't "see how they can make their numbers with only portfolio loans [bank-owned loans]." And Cecala acknowledged that, given the relatively small number of bank-owned loans that may qualify for modifications, banks would seem to have quite a challenge ahead of them if they want to reach $17 billion in modifications by primarily using bank-owned loans.
If banks do pay much of their penalty by modifying private investor-owned loans, that would extend the deal's coverage beyond a favored group of bank-owned loans to a wider swath of distressed mortgages.
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