One of the criticisms of the Making Home Affordable Plan unveiled by the Obama administration last month is that it was light on specifics on how to deal with the many homeowners who have second mortgages on their properties. The second mortgage holders generally have to consent to mortgage modification of the first mortgage (through subordination) or a short sale. And since they are often completely out of the money due to homes being so far underwater, they can and do hold up any modification or short sale plans by refusing to play along unless they get a pay-off.
This is particularly an important problem in Arizona because so many buyers used second mortgages here. The price depreciation on homes has been so steep that homes are far enough underwater that the second doesn't expect any payoff. So they simply refuse to consent to anything unless they get paid some amount of cash by the borrower (who typically don't have it).
Today, the Obama administration put some meat on the bones of the original plan to try to deal with reluctant second mortgage holders. I wrote back in March about the initial proposal:
A few points that affect many Arizona homeowners are how the modification program deals with junior or second mortgages and provisions for short sales or deeds in lieu of foreclosure (DIL). The modification program only applies to first mortgages and many (most) Arizonans have a second mortgage on their property. To deal with this, the modification program allows up to a $1,000 payment to a second lienholder to forgive the debt and $500 to the servicer of the secondary lien. Alternatively, the second lienholder can simply agree to subordinate to the modified first loan with no payment.
So the original plan contemplated a pay off of the second mortgage holder by the federal government and a full forgiveness of the debt (essentially a 100% principal write-down on the second). Or the lender could keep the mortgage and simply subordinate to the modified first loan without any financial benefit. This was obviously an attempt to get second mortgage holders to take what money they could and forgive the loan (and good thing for borrowers).
Apparently this was not satisfactory to second mortgage holders who wanted to maintain the lien on the property while still getting a payout. Second mortgage holders don't want to forgive the debt because they have to then write-down the value of the loan, which hurts their balance sheets. And many of the largest banks participating in the TARP program have large portfolios of second mortgages - so have a directly line to Treasury Secretary Geithner to request such things. These banks may also be holding out hope that at least a portion of these distressed borrowers will stay in their homes for the next 30 or 40 years to pay off the loan (and a few might).
So Treasury has devised an additional plan to pay second mortgage holders $500 up front to participate in a modification of the second mortgage at a lower interest rates, with additional payments of $250 per year for up to three years - as long as the borrower does not default. So the bottom line is that both the first and second mortgage holder will get a cash payout from the federal government for agreeing to modify the loan to a lower interest rate. But neither will have to actually forgive any portion of the principal.
These payments will hopefully incentivize second mortgage holders to cooperate in the Making Home Affordable modification plan which is being implemented by many of the big banks as we speak. It's a good step forward to try to find a middle ground with banks that will incentize their cooperation.
Hope for Homeowners Incentive
Additionally, the administration announced that it will give up to $2,500 per loan for mortgage holders to participate in the as-yet-failed "Hope for Homeowners" program.
The H4H program was originally meant as a way to get banks to write down loans to the market value of the house and then the borrower would share any future increase in equity value with the bank. Obviously it makes no economic sense for a bank to voluntarily participate in this, since this requires an immediate principal write-down - again doing harm to the balance sheet (which they are trying to avoid at all cost). And in a market with rapidly falling housing values, it made no sense for a borrower to participate. They would again be underwater within a month. Once housing prices hit bottom, it may make more sense for borrowers to pursue this option, but I don't see why banks wouldn't just continue to pursue loan modifications under the Making Home Affordable Plan, instead of writing down principal under the H4H program.
If the new bankruptcy bill allowing mortgage cramdowns ever gets passed, this program may again be in play as banks choose H4H as an alternative to judicial bankruptcy principal write-downs.
The article from the AP about the actions today can be found here.
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