The key to success of the Home Affordable Modification Program (HAMP) lies in the long-term sustainability of the modifications offered to troubled borrowers. If the modification results in a payment that is still unaffordable or the home is worth much less than what is owed on the mortgage, the likelihood of a borrower re-defaulting on his or her loan increases. Additionally, a servicer may be less likely to grant a modification to a severely underwater borrower because of the added risk of default. While the previous incarnation of HAMP was designed to address unaffordable subprime mortgages, it was not equipped to effectively address unemployed borrowers with little to no income or severely underwater homeowners.
Key changes to HAMP and FHA are detailed below.
- The new HAMP guidelines require considering principal write down alternatives and contain incentives for servicers to write down mortgage principal. When a participating servicer considers a borrower for HAMP, the servicer inputs data about the borrower into a net-present value (NPV) calculation that will show whether the modification will be more profitable than a foreclosure; if the modification is more profitable, the servicer must offer the modification. The new guidelines require that servicers also consider an alternate NPV calculation that incorporates new federal incentives for principal forgiveness. However, the servicer is not required to offer principal forgiveness if that NPV is higher than the original NPV. If the servicer chooses to write down principal, it will be structured as a principal forbearance for the first three years; a borrower must “earn” the write-down by staying current on their payments during that time period. These write-downs not only reduce the risk of default after a modification has been granted, but could also increase the number of trial and permanent modifications offered to borrowers under HAMP by mitigating the risk of default that comes with underwater mortgages.
- The new FHA guidelines are designed to encourage principal forgiveness and allow borrowers to refinance into lower cost loans. The new FHA program, which is voluntary for lenders and borrowers, would allow eligible homeowners who are current on their mortgages and have mortgage balances worth more than 115% of their home value to receive a principal write-down to no more than 115% of home value and refinance into FHA loans.
- The new guidelines expand unemployment assistance under HAMP. HAMP servicers will be required to reduce monthly payments to 31 percent of monthly income for eligible unemployed borrowers who can prove receipt of unemployment insurance. The assistance will last for at least three months, up to six months. After the assistance period, the borrower will be considered for a regular HAMP modification or the Home Affordable Foreclosure Alternatives program, which encourages short sales or deed-in-lieu transactions.
- Participating HAMP servicers are now required to prove in writing that a borrower has been considered for HAMP before proceeding with a foreclosure sale. Foreclosure sale will also be prohibited in a 30-day period after a HAMP denial has been issued so that the borrower has time to respond.
Special Inspector General calls for change in direction
The changes to HAMP and FHA come on the heels of a recent report from the Special Inspector General for the Troubled Assets Relief Program critical of HAMP’s ability to ensure sustainability of its modifications in the long term. The report called for Treasury to consider ways of addressing underwater mortgages, noting that the estimated ratio of outstanding mortgage balances to property value for the average HAMP borrower is 114 percent.
However, the report also raised concerns about Treasury’s method of calculating affordability that have not been addressed by the latest HAMP program changes. Servicers are not required to consider a borrower’s “back-end debts”—such as car payments, student loans, credit card debt, and second mortgages—when deciding whether a borrower can afford the monthly payment. Half of HAMP borrowers in permanent modifications have total debt-to-income ratios of 59.8 percent or more, as of February. As a result, the modified payments may still be too high for the borrower to afford. The FHA changes, however, do state that the new monthly payment must keep total debt-to-income ratios below 50%.
Bank of America begins voluntary principal write-downs
Bank of America also recently announced that it would begin writing down principal by up to 30% for borrowers in certain kinds of risky mortgages whose outstanding loan balance is at least 120% of the home value. The borrower would have to earn this principal reduction by staying current on their monthly payments for five years.
Woodstock Institute welcomes the new changes to HAMP and FHA. The new design of the programs takes into account important factors like unemployment and underwater mortgages that influence borrowers to default. These programs have the potential to stabilize the housing market and keep more people in their homes; however, given the voluntary nature of the program, only time will tell how large the impact will be.