Effective Immediately – No Refi’s For Borrowers with Modified Loans

1/5/09 – EFFECTIVE IMMEDIATELY - Modified Loans are Ineligible For Fannie/Freddie Refi’s, while FHA MAY Be Eligible.

I have not verified this with the GSE’s personally. I have second-hand verification from the GSE’s and first-hand verification from three national Fannie/Freddie seller-servicers in the past week.

In an interesting move that GMAC announced early last week to select correspondents, they will not be accepting any Fannie/Freddie refi’s that have been previously modified/restructured. In my experience, most mods result in one of more of their definitions of ‘restructured.’

A restructured loan or short payoff is a mortgage loan in which the terms of the original transaction have been changed, resulting in either absolute forgiveness of debt or restructuring the debt through either a modification of the original loan or origination of a new loan that results in:

• Forgiveness of a portion of principal and/or interest on either the first or second mortgage;
• Application of a principal curtailment by or on behalf of the investor to simulate principal forgiveness;
• Conversion of any portion of the original mortgage debt to a “soft” subordinate mortgage; or
• Conversion of any portion of the original mortgage debt from secured to unsecured debt

At first I thought this was a GMAC specific event, but in their note they specifically say “Fannie Mae and Freddie Mac will not purchase or accept delivery of a restructured loan refinance. Therefore, all restructured loans are ineligible for conforming loan financing.”

All Sorts of Consequences

This has all sorts of consequences for homeowners, banks, distressed loan and debt investors, broader refinancing, future loan defaults, walk-aways and foreclosures. It may even give us a glimpse of where this is all going – towards principal balance reductions as the best method of quickly forcing home owners to de-leverage. The intent is to make them free to go sell, buy, refi, save and shop.

As soon as I received this announcement, I immediately inquired with two other large-named Fannie/Freddie seller/servicers last week as to their position. They both told me that they are discouraging originating and underwriting modified loans and that they will only approve modifications in certain instances. They are both planning to make formal announcements shortly.

The word I received second-hand regarding the GSE’s stance is that they will buy these loans as part of large bulk packages from very solvent seller-servicers as part of ‘the greater good.’ This does not matter, however. Knowing that the GSE’s frown upon modified loans, originators will not write these loans out of fear that they could get stuck with them. The last thing they want is to have their pipelines peppered with modified loans and little way of identifying them for bulk sale. The banks will just use the GSE’s ‘greater good’ purchases as a way of dumping toxic loans already in the system.

The GSE’s are now treating loan modifications as toxic, just like they treat a recent bankruptcy or foreclosure. This is happening, of course, as they push their new loan mod initiative that they say will ‘help’ millions of home owners. I would hate to see what they could do if they were out to get you. FHA may insure these borrowers only under certain circumstances, and at extreme risk to the lender’s FHA scorecard (SEE FHA EXAMPLE BELOW). With a 50%+ post-mod recidivism rate being reported, it is not surprising this is happening.

‘Mods in a Box’

As I have written many times before, the ‘mods in a box’ from FDIC and the GSE’s keep borrowers over-leveraged, underwater, renters for life. This is because of the way they are structured with teaser rates, lengthened terms, deferred principal and interest and large balloons. This move from the GSE adds to the pain.  Now, for every loan mod that is done, a homeowner is taken out of the housing and US economic equation for a long time. This is especially bad for those in otherwise good shape with equity in their homes and good credit who only got a loan mod to assist with a large reset etc.  This is just another group in addition to the negative-equity crowd (the majority in the bubble states), who can’t benefit from low rates.

This could also be a big blow to the booming loan modification sector. When home owners are told they have very little choice for financing in the future if they accept the mod, they may think more than twice about it. With few ‘post-mod’ options available, walking away and renting may become a much better solution than being trapped upside down in a home with no hopes of future financing. Remember, many mortgage mods are sold as a way of ‘getting straight’ for a year or two, waiting for the housing market to ‘come back’ and then refinancing into a low-rate prime loan.

Adding insult to injury, most mods also come with pro-lender non-recourse provisions, which keep the borrower from getting rid of the mortgage debt through foreclosure. Add to this that the borrower loses the right to sue the originating lender for predatory lending violations.

Whole Loan or MBS Owners

Banks or other entities that own whole loans or securities derived from them may learn really quickly that old vintage loans are going to stay on the balance sheet for a long time, especially if they go delinquent or default and get modified.  The liquidation or vulture investment strategy of ‘buy distressed loan, modify, label it ‘re-performing,’ then refi or sell’ may not work any longer because the buyers on the other end may not want to hold a mortgage loan in which the borrowers are trapped.

Proactive loan mods that do not re-underwrite the borrower according to what they really earn using time-tested 28/36 debt-to-income ratios, market-rate financing and principal balance reductions just kick the can down the road in the majority of cases.

Loan owners may now find it better to foreclosure quickly and sell the property at today’s prices. This sure seems more prudent to me than collecting years of monthly payments from trapped borrowers with modified mortgages and teaser rates. This is especially true if the loan owner thinks he might have to foreclose years from now when prices may have fallen by double-digit percentages. Banks may realize all of this soon enough and either curtail loan mod initiatives or start liquidating these assets at values consistent with the known risks. There is a thriving market for distressed mortgage assets, including whole loans, REO and MBS, but not at the price points most owners think their assets are worth.

Principal Balance Reductions

Do not be surprised that if over the short-term, the movement goes towards large scale principal balance reductions – partly due to this and partly due to bank-unfriendly cram down legislation that might be passed. Partly due to common sense… it is quickly becoming apparent to the banks and MBS holders what they already knew for a long time — the only way to quickly and permanently ‘fix’ the housing and mortgage markets and consumers’ balance sheets is to undo the bad years of 2003-2007. To ‘undo’ means to:

• a) force home owner/consumer to de-leverage through mortgage principal balance reductions based upon time-tested 28/36 DTI and what the borrower really earns using market-rate financing
• b) make it so home owners can freely refinance and sell their homes
• c) make it so the vitally important move-up buyer comes back
• d) significantly reduce defaults and foreclosures without making home owners underwater, fully-leveraged, renters for the rest of their life as the present FDIC, Fannie/Freddie and bank mortgage modification plans do
• e) allow home prices to fall to attractive multiples of rents and incomes without exotic loan programs or artificial, temporarily, government induced low mortgage rates

I am still a big fan of mortgage mods done the right way, as I have written many times.  Some borrower’s may even benefit from the FDIC’s and GSE’s ‘mods in a box.’  There are many private mortgage mod firms out there that do get great results for borrowers. But this sector may quickly turn into an unregulateable nightmare that will hurt thousands of homeowners.

FHA May Not Even be Able to Help

Lastly, most borrowers that are late or in trouble can’t even get traditional FHA financing. Below, GMAC published their rules for funding a modified loan through FHA. Note that many lenders also must have a 580 minimum credit score requirement for an FHA loan. Typically, when homeowners are having mortgage trouble, their score falls below 580.

Best, Mr. Mortgage

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FHA Financing Rules for Modified Mortgages

• • The rate and term refinancing of a restructured loan using FHA financing is eligible when any of the following apply:
  • Forgiveness of a portion of principal and/or interest on either the first or second mortgage;
  • Application of a principal curtailment by or on behalf of the investor to simulate principal forgiveness; or;
  • Conversion of any portion of the original mortgage debt to a “soft” subordinate mortgage

Restructured loans in compliance with all FHA eligibility and product guidelines may refinance using any eligible FHA product. The loan may not currently be delinquent and there can be no late payments in the last 12 months unless the Total Scorecard decision is Approve/eligible. The current mortgage lender must provide a letter stating that they will not file a deficiency judgment.

Cash out refinance transactions are not eligible if the loan being paid off is a restructured loan.

GMAC will only provide FHA financing for eligible restructured loans not currently being serviced by GMAC.

Example of an Eligible Scenario – (PRINCIPAL BALANCE WRITE DOWNS)

This is the closest I have seen to date of a large financial institution endorsing something close to the Hope for Homeowners FHA refi program that requires banks to significantly write down the principal balance in order to qualify. The H4H program was recently changed to allow for 96.5% LTV’s vs the original 90% in hopes it will give note holders extra incentive to write-down the debt. But most lenders don’t want to originate H4H loans because modified borrowers have such a high re-default rate, it puts their FHA scorecard at serious risk. – Best, Mr Mortgage

1/5 GMAC MEMO TO CORRESPODENTS

A GMAC Bank Correspondent Funding Announcement

CL08-289 Restructured Loan / Short Payoff Policy

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