REQUIRED READING: New home-retention products put forth by both the vendor community and the federal government aim to cure what is perhaps the most stubborn driver of strategic default: negative equity.
Nearly one-quarter of U.S. properties were underwater at the midyear mark, according to CoreLogic. Government-endorsed modifications, as well as servicers' proprietary loan rewrites, overwhelmingly provide monthly payment relief, but only about 2% of modifications include a principal reduction, bank regulators report, indicating equity restoration is atypical.
But earlier this year, in response to the lost-equity concerns of borrowers who are current on their mortgage, the Federal Housing Administration (FHA) announced it would roll out a short-refinance program. The program, officially launched in September, requires existing first-lien holders to write off at least 10% of the unpaid principal. The refinanced FHA-insured mortgage must not have a loan-to-value (LTV) ratio higher than 97.75%, and the new loan's combined LTV must not be greater than 115%. (Second-lien investors and servicers are provided incentives to agree to full or partial extinguishment of liens.) Delinquent loans are ineligible, but borrowers who have made at least three timely payments on a previously modified loan can refinance.
The challenge for the FHA and participants in this voluntary program is to coordinate the many moving parts needed to make a short refi work, especially if the loan is securitized.
"Although it's an origination product, a refi does straddle servicing and origination," says Vicki Bott, deputy assistant secretary for the FHA's single-family programs. The FHA expects servicers to be the likely parties that identify potentially eligible borrowers. The rub is whether servicers will feel comfortable allowing a securitized loan to take a loss through a refinance.
"That's the real complex piece," Bott says. "By doing a short refi, they'd have to feel comfortable that there's a risk the security would have lost more on the loan due to foreclosure or something else versus what they would lose by short paying off the loan."
Bott says the agency is working with servicers and investors to iron out the details, adding that investors in trusts would like to get paid down. "It comes down to ensuring that all the operational pieces are there," she says.
Others, like Lenders One CEO Scott Stern, believe investors and other entities that hold credit risk will be less willing to take a proactive haircut, even if it means chancing foreclosure.
"I think people are much less likely to take a loss on a property in the form of a short refinance than they would be to simply foreclose and hold it and hope the value increases again," Stern says. "I see a stalemate. If we can find a reason to convince servicers and investors to accept a short refinance, then I think you could significantly solve the problem."
For these reasons – and perhaps because of the disappointing level of participation in the FHA's equity-sharing product, Hope for Homeowners (which, Bott notes, has picked up steam in recent months) – the agency is reluctant to commit to a firm projection for how the short refinance will play out. Estimates of how many borrowers will be able to take advantage of the offering range as low as 200,000 borrowers and as high as 1.5 million.
Bott predicts servicer adoption of the short refi will occur in three waves. The first wave will be made up of scratch-and-dent servicers that purchase nonperforming loan portfolios at a discount and then aggressively modify the loans. This class of servicers may look to first bring the loan current and then use the short refi to support consumers on a long-term basis, she says.
Second in line will be portfolio servicers that own the write-down risk. The participation of a third category of servicers, those that are working with securitized loans, will likely determine whether the short-refi program makes a significant dent in keeping current loans that may be on the brink of delinquency.
"I think servicers see these private-label securities are a ripe population for the product, but we need to work through those operational impacts," Bott says.
Beyond the complexities of dealing with securitized loans, the FHA short-refi option requires servicers to have origination capacity. Specialty servicing organizations – the group that Bott says will be the earliest to adopt the option – often do not have such front-office platforms. In many cases, they are teaming up with originators that are going to perform the refinances, she explains.
Even if servicers opt against screening their portfolios for potential short-refi candidates, shops should be cognizant that borrowers may inquire about the possibility, Bott advises.
"Servicers need to think about what type of scripting they have for their line customer- service specialists to adequately answer the questions they have coming in," she says.
Vendors are getting in on the act, too. Bensalem, Pa.-based ISGN Corp. announced in April that it was partnering with EquityRock to create RESET, an equity-sharing loan modification. The product combines ISGN's back-end resources – call center capabilities and loan mod processing centers – with EquityRock's equity-sharing technology.
EquityRock began offering equity-sharing options in origination circles in 2006. That product, called the REX Agreement, allows lenders to assist borrowers with down payments in exchange for an opportunity to share in appreciation. Unlike Hope for Homeowners loans, which Bott notes have not been easy to sell into the secondary market, RESET modifications provide lenders with a shared-equity option agreement. The agreement can be sold into a marketplace under development by EquityRock, according to Lee Howlett, president of ISGN's servicing group.
"To date, no one has used this tool as a way to handle the modification of a distressed loan," says Howlett, adding that RESET would probably be most appropriate for a lender that holds whole-loan risk. According to ISGN's original announcement of the program, lenders write down the borrower's principal balance in order to bring the loan in line with the property's market value.
Part of the reason the current housing recession has lasted as long as it has, Howlett says, is because the mortgage industry has failed to address the debt-forgiveness issue.
"When you think about what happened with [the Troubled Asset Relief Program] – all the monies funneled into banks to keep them healthy and the record earnings that they're now having – it feels like there's enough reserve built for the banksâ�¦to have the proceeds fund some of these rewrites of higher-LTV performing loans," he says.
Howlett and Lenders One's Stern agree that forgiving debt may be worthwhile in instances where borrowers with 6.5% or 7% interest rates have demonstrated the ability and capacity to pay. Stern says he would like to see loan value play less of a role in home-retention refinance transactions. A borrower's ability to repay should be the key consideration in a refinance, he says.
"If the main reason the borrower is underwater is a reduction in equity since they bought their house, to me, I'd rather see that house occupied with a borrower who has a level-set payment they can make rather than another vacant property," Stern says. "The last thing we need is more inventory."
Eating some principal in order to improve the likelihood that a loan continues performing is good public relations, at the very least, Howlett notes.
"If a consumer has a demonstrated ability or capacity to pay, and you, as a lender, are saying, "They're paying at six-and-a-half or seven percent and I can get them into a four percent mortgage if I forgive some debt,' I think that's a very attractive headline, as opposed to foreclosure moratoriums and robo-signing," he says.
(Please address all comments regarding this article to John Clapp, editor of Servicing Management, at firstname.lastname@example.org.)