The fingers of those laying blame for the financial crisis have pointed in a number of directions, including Wall Street investment banks, securities ratings agencies, mortgage brokers, Fannie Mae and Freddie Mac, and politicians on both sides of the aisle. Regardless of who is ultimately at fault, it is undeniable that at the heart of the crisis lie troubled mortgage loans.
For various reasons, including falling home prices, creative loan products, and interest rate adjustments, default rates on mortgage loans increased dramatically over roughly the last two and a half years, from under 5 percent in the third quarter of 2006 to roughly 12 percent at the end of 2008. While the problem initiated in the subprime market and in states like Florida, California, and Nevada, the problem eventually spread through the prime market as well, affecting homeowners nationwide with loans of wide-ranging values. As mortgage defaults became widespread, mortgage-backed securities failed, as did the credit default swaps effectively insuring them, leaving investors with assets of dubious, if any, value.
From a litigation perspective, rising default and foreclosure rates have spawned an escalating volume of foreclosure-related litigation. Borrowers are bringing a variety of claims challenging their loans, the rights of lenders to foreclose, and the rights of lenders to evict. In many of these cases, loan modifications would potentially be the most advantageous resolution for both borrower and lender alike due to falling home prices, increasing days on market, and already inflated lender REO inventories. But modifying these loans is often a difficult proposition for lenders due to high default amounts, and many borrowers are facing pay cuts and layoffs, further stymieing their ability to make monthly payments.
Legislators have been searching for solutions to assist with modifications, but to date an effective solution has remained elusive. For example, Congress passed the HOPE for Homeowners Act of 2008 with the goal of creating an FHA program to help homeowners avoid foreclosure by fostering modifications to reduce principal balances and interest rates. Due to the program’s hard-to-meet requirements, however, it is estimated that there have been fewer than 100 applications nationwide for participation in the program and as few as only one foreclosure actually prevented as a result of the program.
Despite the failure of prior programs, there may yet be hope on the horizon. Just recently, on March 4, 2009, the Treasury Department announced the “Making Home Affordable” program, a new attempt to assist with modifications to avoid foreclosure. The $75 billion program will require participating lenders to reduce payments to no more than a 38 percent debt-to-income ratio (“DTI”). For further payment reductions down to a 31 percent DTI, the Treasury Department will provide lenders with dollar-for-dollar matching to soften their losses. Lenders will have the option to forbear principal, extend loan terms up to 40 years, and reduce interest rates as low as 2 percent for a period of 5 years before they are gradually increased back. Servicers will receive an upfront incentive of $1,000 for each modification under the program, and will also receive additional $1,000 incentive payments for up to 3 years for borrowers who stay in the program. Among the eligibility requirements are an unpaid principal balance of $729,750 or less, and occupation of the collateral property as a 1 to 4 unit primary residence.
Because the Making Home Affordable program is so new, its actual impact, of course, remains to be seen. But changes in this program from its predecessors, such as the elimination of loan-to-value ratio caps for participation, seem to indicate that legislators may be learning from their prior failed attempts, engendering cautious optimism that an effective solution will be found soon.
By J. Garth Fennegan and Michael R. Steinmark