Beginning in May, Bank of America–the “largest mortgage servicer,” in the U.S, according to The Associated Press, will cut principal owed on certain mortgages for some underwater homeowners. In a bid to turn around mortgage loans on homes that are headed to foreclosure, and instead make the loans start performing once again, Bank of America becomes the first major bank to look first at cutting principal, before interest rate reductions.
The program is a result of a settlement with Massachusetts Attorney General Martha Coakley over “predatory lending practices” in Massachusetts by Countrywide Financial Corporation, which was bought by Bank of America in 2008. The Massachusetts settlement includes a payment of $18 million to homeowners in Massachusetts and a “$4.1 million payment to the Commonwealth,” of which, “up to $2.4 million will be distributed to Massachusetts Countrywide borrowers who have already lost their homes to foreclosure,” according to the attorney general’s March 24 announcement.
Bank of America will trim up to 30% of the principal owed on “certain subprime, Pay-Option and prime two-year hybrid mortgages qualifying for its National Homeownership Retention Program (NHRP),” according to the bank’s announcement on March 24. The Bank’s NHRP has programs in 44 states and Washington D.C.
“The bank estimates that it will be able to offer these enhanced principal reduction solutions to about 45,000 customers who qualify for a HAMP modification, for an estimated $3 billion in total reduced principal offered under this NHRP enhancement.”
The Massachusetts settlement “expands an earlier agreement that Countrywide reached with 43 other state Attorneys General and the District of Columbia in 2008 for loan modification for certain delinquent borrowers and builds on standards set forth in the Home Affordable Modification Program (HAMP) administered by the United States Treasury,” Coakley’s statement added.
“The settlement allows for significant principal forgiveness for delinquent borrowers in HAMP-eligible Pay Option ARMs, 2-year Prime ARMs, and Subprime 2-, 3-, 5-, 7- and 10 -year Hybrid ARMs, who owe more than 120% of their home’s current fair market value on their first mortgages.”
Home Affordable Modification Program
The federal HAMP program has had its limits, and so far has modified only “116,000 units,” says Jeffrey Gundlach, CEO of Los Angeles-based registered investment advisor DoubleLine LLC, and former Chief Investment Officer of mutual fund company The TCW Group Inc. That’s a drop in the bucket considering Gundlach’s number of units that are not paying their mortgages–”What happens [to the] 6.5 million units that are not paying?” Some of those are undoubtedly candidates for foreclosure but are held off the foreclosure process informally as banks and regulators try to sort out what to do about the enormous number of homes underwater–worth less than what is owed on them–in the U.S. In part, the issue is first liens, or first mortgages, versus second, junior liens–second mortgages, home equity line of credit (HELOCs). Gundlach puts the dollar amount of second mortgages and home equity loans “on banks’ balance sheets [at] $1 trillion.”
HAMP doesn’t alter the principal owed on a mortgage, and only considers the first (senior) mortgage, revising mortgage payments to 31% of income, but doesn’t look at second mortgages, home equity loans, car and student loan payments, Gundlach explained in an exclusive interview with Wealth Manager on March 18. (Watch for a Podcast of that interview on WealthManagerWeb.com, soon). That makes the “average debt-to-income ratio after modification 59.7%.” The result, he argues, is a “59% redefault” rate for post-HAMP modified homeowners.
Compounding the issue are banks that hold lots of the second mortgages or home equity loans on their books, who don’t want to see principal amounts on these second, junior liens written down–they want to write them off over time.
Only recently, Gundlach adds, there have been quiet discussions and “memos” among bankers and politicians in Washington about cutting the principal amounts owed on first mortgages on homes that are headed for foreclosure. There has been resistance to writing down principal since the beginning of the crisis. For one thing, many of the mortgages are owned by institutional investors that had been reluctant to agree to cut the amount of principal they would be repaid, Gundlach notes. In addition, there is fear of unintended consequences once principal is cut on some mortgage loans: will other homeowners, whose homes are underwater but who are still making their mortgage payments on time, purposely stop paying so that they, too, could negotiate a principal reduction, causing a chain reaction of defaults? No one knows the answer to that, Gundlach says.
Altering the mortgage’s legal contract has also been an argument against forgiving principal of mortgage loans in this downturn. But if Bank of America is beginning this process, is it a sign that other lenders may look at principal reductions for mortgages as well?
Comments? Please send them to [email protected]. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.