The Mortgage Professor

Time for the Government to Go Far Beyond Rate-Freeze Plan for Borrowers

By Jack Guttentag
Saturday, January 12, 2008

Last week, I predicted that the tight mortgage market will ease when investors regain their confidence, which won't happen until they see a floor in house prices and a peak in foreclosures. Neither is yet in sight.

Housing markets are always slow to adjust, partly because sellers are in denial and are stubborn about reducing prices, while many buyers defer purchases because they expect prices to decline. Rising foreclosure rates strengthen this attitude among buyers because buyers understand that foreclosure sales depress prices.

The peak in foreclosures is not yet evident because of the large overhang of interest rate resets on adjustable-rate mortgages. Because many borrowers facing rate resets will find their new payments unaffordable and will not have the equity or credit to refinance, the outlook is for continued increases in foreclosures. The hope, however, is that the relief plan orchestrated by Treasury Secretary Henry M. Paulson Jr. will change this expectation.

The federal government initiated and to some degree orchestrated the plan, the details of which were released last month. No government funding is involved in it, however. It is a private initiative developed by the American Securitization Forum, an organization of firms involved in the mortgage securitization process. The plan applies to just one category of firms belonging to the organization: servicers of securitized ARMs.

The primary goal is to reduce foreclosures of securitized ARMs facing rate resets by extending the initial rates for five years. The eligibility rules are designed to make implementation possible on a wholesale fast-track basis, as opposed to the slow case-by-case basis that is the rule otherwise. It is also intended to be consistent with the contractual obligation of servicers to modify loan contracts only when it is in the interest of the investor.

Borrowers eligible for the fast track:

  • Took out ARMs with initial rate periods of two or three years between Jan. 1, 2005, and July 31, 2007.

  • Face rate resets from Jan. 1, 2008, to July 31, 2010, that will increase their payments by more than 10 percent.

  • Occupy the property as their principal residence and have been current on their payments for 12 months before the rate reset.

  • Will be unable to meet the payment increase, as indicated by a FICO credit score lower than 660 and not more than 10 percent higher than it was at origination.

  • Will be unable to refinance, either because the original loan was more than 97 percent of property value or because they don't qualify for Federal Housing Administration financing.

    Not eligible are borrowers who have already had their rates reset, borrowers with high-rate fixed-rate mortgages, borrowers who made down payments larger than 3 percent, borrowers with good FICO scores, and those who have substantially improved their scores. Many of these borrowers, while ineligible, are also struggling.

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