Mortgage Law

Talking Points: Obama Foreclosure Fix

By Glenn F. Russell, Jr.

In light of President Obama’s “Foreclosure Fix” initiative announced last week, I wanted to send out a memo briefly explaining what the program is supposed to do, who it will apply to, and what the objectives are for this plan.

This plan only applies to those with a mortgage on their principal residence and on mortgages that were taken out “over the past few years” (yet to be defined b the Obama administration), and subject to “caps” as to the amount of the mortgage.

The announcement last week is only the first shoe to drop. The official enactment of Obama’s plan will be announced and go into effect on March 4, 2009.

The second (and I feel the most important step) will be Congress’ taking up the bankruptcy cramdown provision. It’s vitally important that Congress pass this legislation, as this will provide much-needed additional leverage for lenders to “play ball” with borrowers who wish to modify their existing loans. Congress is scheduled to begin debate on the passage of the cramdown provision this week (week of 02/23 – 02/27/2009).

There are two components of the Obama plan: affordability and stability.

Affordability

This part of President Obama’s plan addresses borrowers in Fannie Mae and Freddie Mac- conforming loans who are looking to refinance and, due to current Fannie and Freddie LTV (Loan to Property Value limits), don’t qualify under federal guidelines. This initiative will (for qualified borrowers) have the effect of reducing their loan payments to correspond with a 31% debt-to- income ratio (31% of gross income).

Stability

This part of President Obama’s plan addresses approximately the 3 to 4 million “at-risk” borrowers with mortgages taken out from other (outside Fannie and Freddie) lenders.

Unfortunately, this is a voluntary plan on the part of the mortgage companies. However, in order to create incentives for the lenders, the plan will set aside $75 billion to be used toward incentives (Carrots) aimed at mortgage servicers and lenders to work with borrowers to modify their existing loans.

There are also incentives to borrowers (of up to $1,000.00 per year for up to 5 years) to be applied directly to the principal of the borrower’s loan. In order to qualify for this incentive, borrowers would  have to remain in their homes and maintain mortgage payments under the modified payment terms.

Unfortunately, this part of the plan (stability) is only in effect for five years. Once this period of time expires, the lender can bring the interest/payment rates back to the original terms the borrower agreed upon.

President Obama’s Affordability and Stability Plan (Official Treasury Statement)

•    Read the Homeowner Affordability and Stability Plan Fact Sheet HERE

•    Read Three Example Cases of How Obama’s Plan Can Help Homeowners HERE

Proposed Bankruptcy Cramdown Legislation

The bankruptcy cramdown legislation would be the “stick” to be used on lenders who refuse to work with borrowers.

It’s vitally important that the cramdown legislation be passed by Congress, because I do not feel that the incentives provide enough leverage to get mortgage lenders to agree to a voluntary “write-down” of borrowers’ mortgages. However, if these lenders are faced with the prospect of having a bankruptcy judge bring the secured mortgage debt down to the current appraised value of the property, (the rest would be discharged as unsecured debt), then I believe Obama’s plan would be effective.

•    Currently, bankruptcy judges are precluded from modifying mortgages on primary residences, a practice known as cramdown. Currently, this is allowed on investment properties and second mortgages. Prior to 1978, cramdowns were allowed on all mortgages.

•    In a “cramdown,” the lender’s security interest is reduced to the value of the collateral securing the loan. For example, if you took out a mortgage for $300,000 to buy a home in 2005 and the current appraised value of that home is now only $200,000, a bankruptcy judge could reduce the secured interest of the lender to $200,000.  The remaining $100,000 would then become unsecured debt, which is dischargeable in bankruptcy. This would then have the effect of permanently reducing your mortgage by 1/3 in this example.

•    The House, where bankruptcy reform has already been approved in committee, could take up this measure as soon as this week. (Week of 02/23 – 02/27/2009).

•    The administration has designed a program to lavish incentives on lenders that modify mortgages. The incentives are the carrots to encourage more modifications, and bankruptcy reform is seen by the administration as the stick lenders would face for failing to comply.

•    Obama’s plan requires homeowners to certify that they have complied with requests for information from their lender. Industry officials say that this would help weed out homeowners who received their mortgages fraudulently.

•    Obama’s initiative would cap the value of mortgages that could be revised in bankruptcy court. It would also pertain only to loans originated in the “past few years,” according to a summary of his proposal.

•    How the administration chooses to define several parts of its plan (such as “past few years”), will impact whether tens of thousands of homeowners are excluded. It could affect a lot of people or very few people.

•    Republicans and the financial services industry fiercely oppose the measure, complaining it could drive up mortgage rates and increase losses.

•    Obama’s plan would cap the value of the loans eligible for bankruptcy modification to limits set by mortgage finance firms Fannie Mae and Freddie Mac, which could be difficult in parts of the country that saw the biggest run-up in prices. The conforming loan limit is currently $417,000 in most parts of the country and $729,750 in high-price areas.