Mortgage Bailout: Details on Rates and Incentives

On Mar. 4 the Treasury Dept. released final guidelines for banks and homeowners looking to participate in a new $75 billion program called "Making Home Affordable." Among the new details of the program, which is now up and running: cash payments for mortgage holders who choose not to foreclose on borrowers and new rates as low as 2% for borrowers. The Obama Administration also indicated it will seek changes in bankruptcy laws to allow judges to restructure home loans in court.

"Two weeks ago the President laid out a clear path forward to helping up to 9 million families restructure or refinance their mortgages," said Treasury Secretary Tim Geithner in a prepared statement. "Today we are providing servicers with the details they need to begin helping eligible borrowers."

The mortgage rescue plan, originally announced by Obama in Phoenix on Feb. 18, aims to stem the rising tide of foreclosures by streamlining the way troubled loans are renegotiated. The plan addresses some of the major obstacles homeowners have faced when trying to avoid foreclosure.

Cash Incentive

Mortgage servicers—the companies that process payments on behalf of the ultimate owners of the loans—will now have a financial incentive to change the terms. They'll get paid $1,000 up front for every loan modification. If the borrower stays current on the loan, the servicers will get additional $1,000 payment each year for three years.

Because the government wants people to stay current in their loan payments whether they are seeking to renegotiate or not, mortgage owners and servicers are being encouraged to reach new terms with borrowers before they default. Mortgage owners who reach such agreements will get paid $1,500; mortgage servicers will get an additional $500. Servicers are also being asked to negotiate with the holders of second mortgages and get them to fully extinguish their loans. The servicer will get an additional $250 for that. Because home prices have fallen so dramatically, many second mortgages are now worthless.

The Treasury is making $10 billion available to pay mortgage owners who renegotiate loans now, even if there is a likelihood the home will decline further in price. If the loan modifications don't work and the borrower still defaults, mortgage owners can receive cash payments linked to declines in a home price index.

One of the biggest changes in the new program is the introduction of a simple formula for calculating monthly payments. In the past, banks tried to help borrowers who had fallen behind by tacking missed payments onto the principal of the loan. That did not reduce the monthly payments. More than 40% of all borrowers who get put in such payment plans end up defaulting again, according to the U.S. Office of Thrift Supervision. Under the new program, mortgages will be restructured so that home payments account for no more than 31% of the borrower's gross monthly income. All debt payments, including car loans and credit cards, will be no more than 55% of pretax income.

Drowning in Negative Equity

Borrowers who are "underwater"—that is, they owe more than their house is worth—will also be allowed to refinance so long as their first mortgage does not exceed 105% of their home's value. Previously only borrowers with at least 20% equity in their homes could refinance. Still, the program is not expected to help many homeowners whose homes are now worth far less than the purchase price. A report released on Mar. 4 by LoanPerformance, a mortgage data company, says one in five U.S. mortgage holders were saddled with negative equity at the end of 2008.

Borrowers seeking help in negotiating with lenders are being encouraged to use counselors approved by the Housing & Urban Development Dept. (HUD). These nonprofit firms, such as NeighborWorks America, the Neighborhood Assistance Corp. of America, Acorn, Catholic Charities, and the Urban League, are paid by the federal government to run programs for homeowners in trouble. They typically contract with hundreds of other counseling services across the country, both to negotiate new loan terms and counsel borrowers on overall household budgeting. Their services are free. The involvement of Acorn, which is politically active, has been a bone of contention for conservative critics of the Obama mortgage bailout.

"If you're paying for foreclosure prevention services, you shouldn't be," says Douglas Robinson, a spokesman for NeighborWorks.

The Obama plan will not address all homeowners in trouble. Only loans insured or owned by Fannie Mae and Freddie Mac will be part of the program. Homeowners need to call their lender to find out if that is the case with their loan. Investment properties and second homes will not qualify. Borrowers who took out "jumbo" loans over the new limit of $720,000 will not qualify. The real estate Web site estimates that only about 25% of borrowers have home values high enough to support refinancing under the new program terms. A Treasury-run Web site will have more information about the program.

Out-of-Luck Jobless

The plan also doesn't address borrowers who have no income, such as those who have recently been laid off. Citigroup announced on Mar. 3 that it would lower payments to $500 a month for three months for borrowers who have lost their homes. Other banks may follow.

Meanwhile, the House of Representatives is expected to vote on Mar. 5 on legislation that would allow judges to restructure mortgages in bankruptcy court. Republicans and the banking industry had opposed such moves, fearing a wave of filings that would allow homeowners to easily void contracts. Under a compromise hatched this week by Democratic leadership, judges could approve such "cram-downs" only if the homeowner had first been offered and made an effort at paying under a loan modification structured along the new guidelines.

    Before it's here, it's on the Bloomberg Terminal.