By: Richard Feldman
By: Richard Feldman, CFP®, MBA, AIF®
The current financial crisis was born out of the real estate bubble that developed after the technology bubble burst from 2000 through 2002. The bubble was fueled by low interest rates and easy access to capital. The incentives were too big for mortgage brokers, loan underwriters, and financial services companies to get these substandard credit risk loans pushed through the system. If you read the article in the New York Times, “Was There a Loan It Didn’t Like?” about Washington Mutual’s underwriting practices, you will understand what was going on in the industry. The financial incentives for loan officers and originators was so high that most loans originated in 2006 and 2007 will go into default because most homeowners cannot afford the payment amount upon reset of the adjustable rate. Most borrowers were told they would be able to refinance long before the reset ever happened and we all know how that story is playing out. In fact, a total of 765,558 US properties received a default notice, were warned of a pending auction or were foreclosed on in the third quarter. This is the highest rate tracked by Realty Track which is a California based company that sells default data and has been tracking this information since 2005.
Many economists have stated that the $750 billion bailout package was off target and does not address the real problem going on which is plummeting home prices. If you take it a step further, home prices are not going to bottom out unless you can stabilize the collateral. The reason home prices are falling is the spiral of foreclosures hitting the market every month driving down property values in neighborhoods across the country. John McCain seized the opportunity to make this topic a focal point in his presidential campaign but his idea was not original and has been discussed for almost a year now.
The FDIC’s takeover of IndyMac Bank is providing a framework for a systematic way of dealing with the foreclosure issue by providing a framework to restructure or modify thousands of mortgages that are nearing default or already in default. Sheila C. Bair, Chairman of the FDIC stated, “I have long supported a systematic and streamlined approach to loan modifications to put borrowers into long term, sustainable mortgages – achieving an improved return for bankers and investors compared to foreclosure.”
Under the IndyMac federal program, eligible mortgages would be modified into sustainable mortgages. Modifications would be designed to achieve sustainable payments at a 38% debt to income ratio of principal, interest, taxes, and insurance. To reach this metric for affordable payments, modifications could include a combination of interest rate reductions, extended amortizations (40 year terms versus 30 year terms), and principal forbearance.
JP Morgan and Bank of America
JP Morgan announced a week ago that it will suspend foreclosures on approximately $110 billion of problem mortgages so that they can analyze ways of making payments easier so individuals and families can stay in their homes. The bottom line is that banks are not in the business of owning and servicing property and they are starting to realize that a performing restructured home loan is a much better investment than a foreclosed property sitting on their books accruing property taxes and maintenance fees.
The JP Morgan program is expected to help 400,000 families with $70 billion in loans in the next two years. Additionally, 250,000 families and $40 billion in mortgages have already been restructured through loan modifications.
Bank of America announced two plans this year totaling approximately $120 billion of unpaid balances in terms of suspending foreclosures and working to modify the contractual rates of interest and amortization schedules.
Citigroup recently announced similar programs and the FDIC came out with a program to prevent approximately 1.5 million home mortgage foreclosures by promising to share any losses with mortgage companies that refinance certain home loans.
With the economy in a recession and job cuts being announced on a weekly basis, the only real alternative is to try and restructure mortgages in order to keep homeowners in their homes and the property off banks’ balance sheets. Some homeowners are so under water on their property that they will still choose to give the keys back to the bank. There are, however, millions of Americans that could be saved by the programs mentioned above and who ultimately would pay the banks and mortgage companies a higher amount of interest on the life of most of these loans.