By BILL ABOUMRAD
Editor’s note: Inman News has asked our readers to share their insights about the foreclosure problem that went viral following the subprime mortgage-market meltdown. We are offering a free pass to the Real Estate Connect conference for all published articles, and $200 to the winner of an essay competition. Click here to find out more about Inman’s "Fixing the Foreclosure Crisis" coverage.
The housing crisis in the San Francisco East Bay Area and in many regions of the country has reached dire proportions, with seemingly no end in sight. But it doesn’t have to be this way. There is a five-step solution to fixing the foreclosure crisis caused by poor lending practices of recent years.
The majority of loan defaults associated with residential mortgages can be avoided, but only if the banks holding and servicing the loans are willing to change the way they do business and begin working with their customers.
The current reluctance by banks to work out and modify existing loans with earnest homeowners who want to stay in their houses is unacceptable. For a host of reasons and mostly monetary, banks aren’t talking to their consumers about restructuring their loans unless the homeowner is technically in default. This is just wrong!
The problem with the vast majority of loans going into default is that consumers cannot afford the new monthly rates that are resetting at higher rates. For example, a borrower emerging from a period of fixed and very low "teaser" rates may experience a sudden 2.5 percent to 3 percent increase in the borrowing rate.
Take a "current" $500,000, 30-year loan at 5 percent interest and the monthly payment would be $2,685. At the reset and new rates of approximately 8 percent interest, that same 30-year note would cost consumers $3,670 per month. Who can afford a $1,000 increase in one month?
The first step is for banks to consolidate the separate functions of loan modifications, short sales and foreclosures and begin to work together on their loan portfolios.
By establishing a "Loss Mitigation Department," hard-nosed "short sale" managers could be more accommodating on the front end of a workout and reduce the number of foreclosures that the real estate-owned (bank-owned property, or REO) department later inherits. And by the time a home is foreclosed on, its value is greatly reduced from its status as a short sale.
The second step is for banks to allow borrowers to keep original "teaser" rates a little longer, and then gradually and incrementally raise rates (perhaps 1 percent per year). Due to financial market conditions, borrowers who took out loans from 2003-05 have experienced first-year increases of 2.5 percent or more after the teaser-rate period expired. Banks should view the lower, 1 percent increase as a preservation mechanism to lock in the original "asset" they acquired, namely, a performing loan versus a nonperforming loan. …CONTINUED
The third step is for banks to adjust the amortization schedule of 30-year notes to 40-year notes. Take the earlier example of the $500,000 mortgage with an original 5 percent interest rate ($2,685 per month), increase the rate one point to 6 percent, and modify the amortization schedule to 40 years.
In that case, the same homeowner would pay $2,750 per month, or only a $65 monthly increase from the original loan. Homeowners who remain employed and want to stay in their homes can afford modest increases.
The fourth step, which is good for both banks and consumers, is to tie the modified loans to 10-year balloon payments, with loans to be paid in full or restructured by the end of the term. Popular in the 1980s when interest rates reached 18 percent, balloon payments give consumers an extended period in which homes can appreciate in value, while at the same time providing banks with assets that are more valuable than the adjustable-rate loans they have funded in recent years.
The good news is that restructured or modified loans are NOT new loans requiring loads of documentation and new fees. A workout is simply an addendum to an original mortgage and coordinated with the bank that is servicing the loan. Property titles don’t have to be changed. Lenders just have to verify borrower information (like employment, income) and restructure loans to reflect new interest rates, a revised amortization schedule, and payout period. It is just paperwork.
The fifth step is that banks should accelerate the short-sale process to automatically approve sale requests from brokers in which the bank would recover at least 70 cents for each dollar of its original loan, or if the home can be sold for 90 percent of the current market value. The current market value is usually determined by a combination of a broker price opinion (BPO) and a bank-authorized appraisal.
Banks should be highly motivated to pursue loan modifications. Recent experience tells us that in a foreclosure, bank losses are 50 percent or greater. In short sales, bank losses are typically 35 percent to 40 percent. In loan modifications, bank losses are approximately 25 percent, and now — with federal assistance and incentives — actual bank losses should be only 10 percent to 15 percent.
Homeowners who want to stay in their homes and are at risk of mortgage default should call their lenders and ask for loan modifications. Banks should change the way they manage their loan portfolios. We can stop the hemorrhaging in the housing and financial markets if we take these steps to solve existing problems.
Bill Aboumrad is co-owner and founder of Legacy Real Estate & Associates, based in Fremont, Calif. He has participated in numerous committees and subcommittees for the National Association of Realtors and California Association of Realtors trade groups. He is past president of Bay East Association of Realtors and is the current vice president and a board member of MLSListings.
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