Friday, February 11, 2011

Government-Sanctioned Loan Modifications More of a Bitter Pill than a Cure

Loan modifications are not the magic pill to cure America’s foreclosure crisis the government had hoped they would be. Its high-profile Home Affordable Modification Program (HAMP) at best has only stalled, not stemmed, the tide of defaults facing American homeowners. When introduced in March of 2009, HAMP aspired to provide much-needed relief during the economic downturn with a $50 billion war chest to incentivize lenders and servicers to offer loan modifications to distressed borrowers. The goal: 4 million loans modified under HAMP. The reality: out of only 1.7 million trial modifications, only 579,000 have become permanent modifications as of December, 2010. Approximately 1 million borrowers simply didn’t qualify for the program and are again staring down the barrel of default. The Federal Government’s program to fix the problem has been widely criticized as a failure, prompting Congress to introduce legislation in January, 2011 to kill the program.

What happened? Qualifications for HAMP seemed simple enough: if the loan was an owner-occupied first lien, originated before 2009, on a clear path to default, with a principal balance under $729,750 and monthly payments exceeding 31% of the borrower’s gross income, it would meet the program guidelines. The grim truth is that even with lower terms negotiated for homeowners, many of them still couldn’t make the monthly payments during the trial period due to economic hardship or they couldn’t submit the proper documentation required for income verification under HAMP. Approximately one year after HAMP’s debut in March, 2010, the government conceded loan modifications weren’t enough to tackle the crisis and introduced another program: HAFA.

HAFA, the Home Affordable Foreclosure Alternative, addressed distressed homeowners who couldn’t sustain monthly payments by making a short sale a viable option. In essence, the lender provides the short sale option if it appears that the HAMP-modified loan may default within a three-month period. As an incentive, individual borrowers walk away with $3,000 for relocation, their credit intact, and they are released from the burden of default. Lenders and investors walk away with one less banked-owned property along with financial incentives to cover some administrative costs and to help satisfy subordinate liens on the property.

And as of February 1, 2011, HAFA guidelines were modified to benefit investors as well: non-owner occupied properties now qualify for relief under HAFA. As long as the property has been unoccupied or used for rental income for no more than 12 months prior to the date of the Short Sale Agreement, and the borrower has not purchased a new property during that same time period, income property owners as well as homeowners can benefit from the program. FHA-insured loans, as well as loans guaranteed by Fannie Mae or Freddie Mac, are excluded from HAFA qualification.

When HAMP fails, the HAFA short sale alternative may be the right prescription for homeowners to free them from the burden of mortgages they cannot afford. Only time will tell if HAFA will be more effective than its older cousin in providing relief to homeowners seeking a way out of their mortgages.

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