A Good Credit Score Puts Help at Risk

By Kenneth R. Harney
Saturday, December 15, 2007

It may be the only test you flunk if you score too high: It's called the FICO credit-score test, and it is a key element of the sometimes-arcane guidelines governing which homeowners qualify for "fast-track" interest rate freezes on their subprime mortgages and which don't.

The rate freeze and loan-modification program, announced Dec. 6 at the White House, is a voluntary effort by major lenders, mortgage servicers and bond investors to provide alternatives to foreclosure for homeowners facing unaffordable payment resets in the next two years.

Of the estimated 1.8 million subprime borrowers facing payment jumps, the plan is expected to help 1.2 million into either an expedited rate freeze, a refinancing or a modification that makes their current loans more affordable. The rate freeze has attracted much of the media attention, but the precise details of how it works and who is eligible have been less widely publicized.

Here is a quick overview of the tests that subprime borrowers will need to pass to qualify for an interest rate freeze, generally for five years:

Tops on the list is the FICO test. In this exercise, scoring high is bad. Scoring low keeps you in the game. If your FICO credit score was under 660 when you applied for your loan and -- here's the kicker -- hasn't improved by more than 10 percent in the meantime, you pass the test.

In other words, if you qualified for your loan with a FICO score of 675, which in a traditional mortgage-application context should qualify you for reasonably good terms, forget about a fast-track rate freeze. Your credit is too good, and you flunk. On the other hand, if you've got a FICO score of 610 or 620 -- subprime credit territory by most lenders' standards -- then you pass.

The idea, according to Tom Deutsch, deputy executive director of the American Securitization Forum and one of the principal drafters of the plan, is to weed out borrowers who may be creditworthy enough to successfully pursue refinancing outside the new system. The rate-freeze plan, Deutsch said in an interview, is aimed at pinpointing borrowers whose credit probably won't qualify them for a refinancing and who are also unlikely to afford future payments on their current mortgages.

Now for the second test: If you want an expedited rate freeze on your mortgage, you must be "current" on your loan payments. "Current" in this context does not mean you always pay on time. Rather, it means that you're not more than 30 days behind and haven't been more than 60 days late at any time in the past 12 months.

An alternative, and more generous, standard used in the program allows homeowners to be no more than 60 days late at the moment and no more than 90 days late in the past year. That may not be everybody's definition of "current," but it works for a fast-track rate freeze.

Next comes the LTV test. LTV stands for loan-to-value ratio -- essentially a measure of how much equity you've got or the size of the down payment you made. Here again, doing "better" gets you busted. To succeed on the LTV test, you should have minimal equity in the house -- less than 3 percent. If you have more equity than that, goes the reasoning, you are less likely to default on the loan and more likely to qualify for refinancing. So you're out.

There are two final tests, both relatively straightforward: You have to occupy the house as your principal residence, and your monthly payment must be scheduled to increase by more than 10 percent after the reset of your loan rate.

Assuming you pass these tests, and your mortgage servicer believes there is a "reasonably foreseeable" prospect that you would default on your loan without a rate freeze, you are in. The rate freeze you receive, by the way, won't necessarily be limited to five years. It all depends on your mortgage servicer's evaluation of your financial situation.

But what if you're part of the expected majority of subprime borrowers who flunk one or more of the tests to get a fast-track rate freeze? There's good news: You're still in the game. You may qualify for some other form of customized loan modification: a payment restructuring plan, a partial forgiveness of past arrears, a postponement of part of your debt or, in rare cases, a rate reduction.

For more information, contact your loan servicer or call the Homeownership Preservation Foundation at 888-995-HOPE.

Ken Harney's e-mail address is kenharney@earthlink.net.

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