Southern California Bankruptcy Law Blog

Home Mortgage Modification And Bankruptcy – Part II

Posted in Home Loans, Home Mortgage Modification

In my last post I focused on housing because I think it’s the most important factor in the current mess.  This post discusses the programs set up to address the mortgage meltdown.  The feds also view housing as the linchpin.

I.          HAMP, HAUP, HAFA, HARP

These stand for “Home Affordable Modification Program”, “Home Affordable Unemployment Program”, “Home Affordable Foreclosure Alternatives Program”, and “Home Affordable Refinance Program”.

            A.        HAMP

Freddie Mac states:

HAMP is a loan modification program designed to reduce delinquent and at-risk borrowers’ monthly mortgage payments.  HAMP is effective for mortgages originated on or prior to January 1, 2009, and will expire on December 31, 2012.

Contractually the borrower agrees to repay the loan with interest according to the contract’s terms.  In modifying the loan, what is the borrower trying to do?  Some combination of:  lower the balance, lower the monthly payments, lower the interest rate.  The common theme:  the borrower wants free money. 

If a bank gives away free money it dies.  For example, if a bank has 100,000 mortgages and lowers the principal balances by $10,000, it loses one billion dollars.  If it lowers the payments by $500 each, it loses fifty million dollars a month.  The $500 figure is the Treasury Department’s standard HAMP monthly mortgage reduction.

Banks have an incentive to modify mortgages:

Servicers will receive $1,000-$1,500 for each eligible modification they establish, and a “Pay for Success” incentive of up to $1,000 each year for three years as long as the borrower does not become 90-days or more delinquent.

But this puny incentive won’t coax a bank into giving a borrower $10,000, or $500 per month, in free money. 

Borrowers start the modification process with a 90-day trial period of temporarily reduced payments.  After being in the 90-day trial period for eight or ten months, with no modification in sight, and receiving a notice of default as a prelude to foreclosure, they seek bankruptcy assistance.

Very few of my clients successfully complete a modification, and those who do end up worse off.  Typically, a completed modification gives a temporary reduction in payments – say for a couple of years – followed by a huge step-up in the payments.  After all, if the bank temporarily gave free money to the borrower, it wants that money back with interest.

Using ProPublica’s dataBarry Ritholtz observes:

[M]ore than half of the 1,426,833 mortgage mods — 54.3% — have failed. . . . The four largest banks dominate — Bank of America (212,094), JPMorgan Chase, (137,765) Wells Fargo (122,732) and Citi (91,742) — followed by everyone else.  The 4 biggest big banks — despite their economies of scale and alleged expertise – have a much higher failure rate than the entire group overall.  They range from 59-62%, versus 54% for the average — a full 10% worse than the median. . . . 729,109 trials have been canceled, 44,972 homeowners have defaulted on the permanent modification, and 590 more have paid off the loan after getting a modification.

Indeed, according to ProPublica’s Olga Pierce and Paul Kiel HAMP has been a terrible failure.

Getting modification representation in California is almost impossible because Cal. Bus. & Prof. Code § 10085.6 prohibits an attorney from receiving any fees until the conclusion of the process.  Since most loan modifications crash and burn, attorneys generally don’t do loan modifications.

            B.        HAUP

HAUP started on August 1, 2011, and will last until December 31, 2012.  HAUP allows some unemployed borrowers to stop making mortgage payments if they meet HAMP requirements.  But someone who can’t get a modification under HAMP isn’t going to get HAUP relief either.  There are no data on HAUP yet since the program just went into effect.  But given the HAMP track record, I suspect that HAUP’s success will be less than sterling.

As a postscript to my HAMP comments, Jim Puzzanghera of the Los Angeles Times observed that when President Obama announced a one-year forbearance on mortgage payments for unemployed homeowners whose mortgages are federally insured, he “admitted . . . that . . . efforts — such as the much-maligned Home Affordable Modification Program, which offered incentives to banks to lower monthly payments for troubled borrowers — haven’t tamed the problem.”  Thus, even the president has had to acknowledge that HAMP has been a failure.

            C.        HAFA

According to the U.S. Treasury:

The Home Affordable Foreclosure Alternatives (HAFA) Program provides additional options to avoid costly foreclosures and offers incentives to borrowers, servicers and investors who utilize a short sale or deed-in-lieu (DIL) to avoid foreclosures . . .  In a short sale, the servicer allows the borrower to list and sell the mortgaged property with the understanding that the net proceeds from the sale may be less than the total amount due on the first mortgage.  Generally, if the borrower makes a good faith effort to sell the property but is not successful, a servicer may consider a DIL.  With a DIL, the borrower voluntarily transfers ownership of the property to the servicer – provided the title is free and clear of mortgages, liens and encumbrances.  With either the HAFA short sale or DIL, the servicer may not require a cash contribution or promissory note from the borrower and must forfeit the ability to pursue a deficiency judgment against the borrower.

Given the anti-deficiency California statute that prohibits a foreclosing lender from seeking to collect a post-foreclosure sale deficiency, it is unclear what benefit HAFA confers on a borrower who does a short sale.  Moreover, the borrower has a potential tax liability on the deficiency because it is discharged outside of bankruptcy.

            D.        HARP

According to Fannie Mae:

A critical part of Fannie Mae’s role in the Making Home Affordable Program is the Home Affordable Refinance Program (HARP), available for refinances of existing Fannie Mae loans only.  The goal of the refinance effort, as announced by the President, is “to provide access to low-cost refinancing for responsible homeowners suffering from falling home prices.” The expectation is that refinancing a Fannie Mae loan will put responsible borrowers in a better position by reducing their monthly principal and interest payments or moving them from a more risky loan structure (such as interest-only or short-term ARM) to a more stable product.  Our solutions provide mortgage refinances for current LTVs up to 125 percent, and mortgage insurance flexibilities.

In essence, HARP is designed to refinance option ARMs.  However, the main reason the option structure was introduced was to enable borrowers who were borrowing more than 80% of the value of the property to reduce their monthly payments.  If HARP allows refinancing of up to 125% of loan to value, defaulting borrowers will not be able to afford monthly payments on loans that are 125% of their home values.  Admittedly, the home values are lower now than at the height of the real estate bubble.  But they are still high enough that someone borrowing 125% of the value will have difficulty making the monthly payments.

II.        Somewhat Cynical Summary

I strongly suspect that the main reason for these programs is not to save homes, but to spread foreclosures out for years rather than have an avalanche all at once.  Most people seeking to modify or refinance their loans are trading one unmanageable loan for another unmanageable loan.  But as long as the process postpones the inevitable foreclosure sale, it slows down the further drop in housing values.  I don’t think the architects of these programs really believe they will save very many homes.  They are hoping to avoid the worsening of an already ailing economy – at least until after the next election (is it coincidence that these programs terminate in December 2012, the month after the next election?).