Interest rates on some subprime and ‘option ARM’ loans will temporarily go as low as 2.5%.
By E. Scott Reckard
October 24, 2008
With calls growing for stronger action to help troubled homeowners, consumer advocates are hailing a mortgage-modification program being implemented by Bank of America Corp.’s Countrywide unit as the most ambitious effort yet to avert foreclosures.A key lawmaker is demanding that other mortgage lenders adopt the program, which was called for by a settlement of state lawsuits alleging that Countrywide borrowers were systematically tricked into taking out unaffordable loans.
Previous attempts to modify home loans, including a freeze on subprime “teaser” interest rates promoted by Treasury Secretary Henry M. Paulson last year, have disappointed proponents of large-scale loan workouts.Federal Deposit Insurance Corp. Chairwoman Sheila C. Bair, who recently criticized the Bush administration for not doing more to stem foreclosures, told a Senate panel Thursday that the government should guarantee modified mortgages as an incentive for companies to ease loan terms.
Her testimony came as figures released Thursday showed the number of families in California losing their homes rose to a record high of almost 80,000 in the last three months.
The Countrywide plan, which is aimed at borrowers with subprime mortgages or pay-option adjustable-rate home loans, known as option ARMs, would temporarily cut interest rates on some loans to as low as 2.5%. Some borrowers who owe more than their homes are worth could even see their loan balances reduced, giving them equity once again in their properties.
The idea is to modify a loan’s terms just enough to create a new monthly payment, including principal, interest, taxes and property insurance, equal to 34% of a borrower’s verified monthly income.
Charlotte, N.C.-based Bank of America, which bought Calabasas-based Countrywide in July, estimates that the effort could cut borrowers’ payments by as much as $8.4 billion.
Bank of America officials say they have obtained permission for the modifications from the vast majority of the big banks, investment funds and institutions to which Countrywide sold most of its loans while continuing to service them. Such investors have blocked many earlier efforts to modify loans, Countrywide and other loan servicers said.
A spokesman for U.S. Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, called the program “the first truly comprehensive plan we’ve seen from the private sector.”
Frank last week gave 10 other major mortgage-servicing companies an ultimatum to adopt programs similar to the Countrywide plan. If the servicers don’t comply, “we’ll write legislation that does it for them,” said Steven Adamske, a spokesman for the lawmaker.
“That sounds like good news, in particular if a huge percentage of other loan servicers go along with it,” said Robert Gnaizda of the Greenlining Institute, a borrower advocacy group. He added, however, that the plan should have included better oversight and outreach to borrowers through community groups.
Although momentum is gathering in Washington for stronger efforts to assist homeowners in distress, such a move would be sure to generate the same kind of bitter opposition that greeted a narrower foreclosure-prevention effort launched by the Bush administration last December as well as the $700-billion legislation recently enacted to rescue the financial system. In both cases, critics said the actions rewarded irresponsible behavior.
Under the Countrywide settlement, the lender and its subprime unit, Full Spectrum Lending, promised to consider modifying any type of loan for borrowers who can’t afford their payments. The accord, however, calls for large-scale modifications of only two types of primary mortgages: subprime loans and option ARMs.
In other provisions, Countrywide agreed to waive prepayment penalties and late fees on distressed mortgages and to freeze the foreclosure process for borrowers until their loans were modified or it was determined that the borrowers didn’t qualify. The lender also agreed to pay an average of $2,000 to borrowers who have lost their homes — or who will lose them because they don’t qualify for the program.
Giving the effort teeth, the settlement gives the state officials who sued, including California Atty. Gen. Jerry Brown and his counterparts in Illinois and Florida, the right to void the settlement and reopen the litigation if Countrywide doesn’t modify 50,000 loans nationwide by March 1.
The ultimate goal is to modify 395,000 loans, including 125,000 in California, according to Countrywide, which became the No. 1 U.S. home lender by aggressively promoting subprime and exotic loans in addition to traditional mortgages.
The modification plan, available only for owner-occupied homes, resembles an approach the FDIC is taking on mortgages serviced by Pasadena’s failed IndyMac Bank, which is now run by the FDIC.
Under both efforts, borrowers who might be helped are to be identified and contacted, even if they haven’t asked for assistance. Both plans provide for sharp drops in interest rates to make loan payments more affordable. A key difference is that the FDIC isn’t offering to reduce amounts owed by IndyMac customers.
By Dec. 1, Bank of America employees are supposed to start contacting and offering loan modifications to borrowers who are 60 days or more delinquent. Borrowers who will face higher payments that they probably can’t afford also will be contacted.
A big chore will be determining borrowers’ incomes because many loans were made with little or no verification of earnings, said Bank of America executive Steve Bailey, who is overseeing the program.
Not every borrower will qualify. One reason, Bailey said, is that the loan owner’s expected earnings on a modified loan must exceed what it would expect to recover in foreclosure. Also, people won’t qualify if their income is so low that they won’t be able to make their payments even after major modifications.
On the other hand, borrowers whose income is determined to be high enough for them to make their payments, even after their rates go up as dictated by the loan’s original terms, won’t be offered help.
Certain complications, including second mortgages and car debts, that in the past might have prevented a first mortgage from being modified, will be disregarded, Bailey said. If the first mortgage can be modified to make the payment equal 34% of a borrower’s income, the plan is to do so and let the borrower work out how to handle the other debts.
The first option to be considered for troubled borrowers with subprime loans and option ARMs would be replacement loans backed by the Federal Housing Administration under Hope for Homeowners, a $300-billion program that became available this month.
The federal program in effect requires a lender to cut the principal to 87% of the home’s current value so that the borrower can receive a smaller long-term, fixed-rate loan. Because Hope for Homeowners is new, it’s unclear how many Countrywide borrowers might get such FHA loans, lawyers in the California attorney general’s office say. Jeff Lazerson, a Laguna Niguel mortgage broker, said lenders appeared to be unreceptive to the fledgling program because of the required write-down of principal.
For subprime mortgages, on which interest rates usually rise after two or three years of a teaser rate, another option would be to revert to the teaser rate for five years. If the borrower can’t afford that, the rate would be cut to as low as 2.5% and then would rise slowly until reaching the original rate or, in some cases, the prevailing rate on Fannie Mae-backed fixed-rate loans.
Similar modifications would be available for borrowers with option ARMs, on which payments eventually soar if a borrower runs up the loan balance by consistently choosing the lowest of several payment options. Such borrowers also could see their loan amounts reduced to 95% of the current value of their homes. The option to let the loan balance rise would disappear.