Tick. Tick. Tick. Tick. Tick.
That’s the sound of the federal government’s Making Home Affordable loan modification program, which is set to explode sometime after 2014.
In case you haven’t heard, the program is the federal government’s latest attempt to reduce the high rate of foreclosures. The program creates a process for loan servicers to modify the mortgages of homeowners who spend more than 31 percent of their income on housing costs and have missed a payment or are in imminent danger of default due to financial adversity. The mortgage payment typically is reduced through an interest rate as low as 2 percent, a term as long as 40 years, and deferral of a portion of the loan balance.
The program has some positive features, but homeowners should be concerned about the longer-term implications.
The program allows the loan servicer to add unpaid interest, property taxes, homeowners insurance premiums and other costs onto the loan balance and then defer part of that balance. No interest is charged on the deferred amount, but the loan now has a balloon payment, which is due whenever the homeowner pays off the loan, refinances or sells the home. The only change in the homeowner’s precarious situation is that repayment is postponed until sometime in the future.
What’s worse is that the low modified interest rate expires after five years. After that, the rate can increase as much as 1 percent each year up to the market rate on the day the loan was modified. That means a 2 percent modified interest rate could pop up to 3 percent, then 4 percent, then 5 percent and then, perhaps, 5 percent and change in the subsequent years. Homeowners who can’t afford the higher payment today may well see that same payment again sometime after the five-year teaser rate on their modified loan expires.
The inducement for homeowners to participate in the program is the avoidance (for now) of foreclosure and a $1,000 incentive payment each year for the first five years of the modification. The incentive is applied to the loan balance, so in effect it chips away $5,000 of the balloon payment, if there is one, courtesy of the U.S. Treasury (read: taxpayers). Five grand is nice but for many homeowners it won’t be enough to make that balloon payment affordable. …CONTINUED
Whether this program is fair or reasonable for homeowners who can’t afford their current mortgage payment is open to debate. Some may insist that homeowners should be obligated to repay every penny they borrowed at whatever rate is allowed per the terms of their loan. Others may feel that’s too burdensome.
But the point here isn’t about homeowner responsibility. It’s about what will happen five years from now when the interest rates on those modified mortgages start to climb. And before you jump at more home sales as the answer, remember that these modified loans may have a 40-year term, a balloon payment or both.
Granted, many of the modified loans may be off the books in fewer than five years, especially since a large percentage of borrowers whose loans have been modified re-default on their loans within a matter of months. Re-default is so common that there’s even a new buzzword for it: "refault." Those who refault, for whatever reason, will be put back into the lender’s short sale or foreclosure queue before the five-year reset occurs.
Being curious, I asked James Lockhart, director of the Federal Housing Finance Agency, about the thinking behind the five-year clock at a real estate editors’ conference in Washington, D.C., this summer. Was the idea that homeowners who received a loan modification would be able to weather the payment shock because their incomes would be higher or their homes would have appreciated in value by the time those adverse consequences took affect?
Yes, Lockhart replied, that was the thinking.
It’s good to be optimistic, and I’d certainly be just as happy as the next homeowner if incomes and home values rebounded that strongly and that quickly. But I’m not sure I’d want to bet my house on that action. For the sake of those who opt to participate in the loan modification program — and their neighbors — we have to hope the government’s optimism isn’t just wishful thinking.
Tick. Tick. Tick. Tick. Tick.
Marcie Geffner is a veteran real estate reporter and former managing editor of Inman News. Her news stories, feature articles and columns about home buying, home selling, homeownership and mortgage financing have been published by a long list of real estate Web sites and newspapers. "House Keys," a weekly column about homeownership, is syndicated in print and on the Web by Inman News. Readers are cordially invited to "friend" the author on Facebook.
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