If you give millions of seriously underwater homeowners a new equity position in their properties by reducing their principal mortgage debt, will they keep paying on their loans and avoid foreclosure?
Call it a pipe dream or a significant model for other lenders and investors, but one company says it has found an important combination: Modify underwater borrowers’ loans so that their payments are reduced to a manageable amount, cut their principal debt over time, and make the deal dependent on their scrupulous on-time monthly payments of the new amount and an agreement to share a portion of any profits they make if they sell the home in the future.
In practice, the plan works like this: Say you’ve been underwater on your loan. You can’t handle the current payments, and you’re heading down the conveyor belt to near-inevitable default and foreclosure. Now the company servicing your mortgage makes you this multi-part offer: First, we will reduce your loan balance to a level where you will have 5 percent positive equity in the house. That is, rather than the original value of the property that has you drowning, we will set your debt at 5 percent below the current appraisal value of the house.
Next, we’ll modify the mortgage so your monthly payments reflect the reduced underlying principal balance. Then, in annual increments over the next three years, we will write off the amounts of the original debt balance that we reduced. In exchange, we will expect that you do two things: Stay current on your loan payments and agree to let us share 25 percent of any future gain you make on the house at resale.
That’s the deal Ocwen Financial, one of the largest servicers of distressed home mortgages in the country, began offering more than 3,000 underwater borrowers in a pilot program that began a year ago. The results to date: 79 percent of the customers who were offered the test program signed up, and the re-default rate has been 2.6 percent — far below the 40 to 50 percent rates within similar periods in some federally sponsored loan-modification efforts.
Ocwen, which services 460,000 loans and is acquiring a portfolio of 250,000 more next month from Goldman Sachs’ Litton Loan Servicing unit, said the test was so promising that it is taking the program national. It has regulatory green lights in 33 states and expects more states to approve it in the months ahead.
Ron Faris, Ocwen’s chief executive, says the key to the program is that the shared-appreciation approach allows for a restoration of equity for borrowers, which is “psychologically important” and greatly affects their motivation to keep current on the modified-payment terms. It gives them a stake again and gives them some hope.
“Our analytics tell us that an underwater loan is one and a half to two times more likely to re-default than one with at least some positive equity,” he said.
The shared-appreciation and principal-reduction concept also works for the bond investors who actually own the mortgages, Faris said. The loans keep performing — unlike many other modification plans — and there’s the possibility of a little sweetener at the end in the form of a portion of any appreciation that occurs beyond the revised appraised value on the house.
As it is now structured, there is no cutoff level of negative equity beyond which the program cannot go, said Paul Koches, Ocwen’s executive vice president and general counsel. So even if your current loan-to-value ratio is 150 percent, which puts you deeply underwater, you might qualify for the program.
There’s a key limitation, of course: Only Ocwen-serviced borrowers who are underwater and unable to handle current loan payments are eligible. Because roughly 11 million owners are underwater on their loans, according to industry data, and 2 million of them are in financial distress and projected to go to foreclosure, Ocwen’s program can only touch a modest fraction at best.
Some large lenders and servicers such as Bank of America and Wells Fargo have initiated principal-reduction efforts for some underwater customers, but none so far have announced a shared-appreciation feature.
Ocwen’s program is drawing praise from consumer advocates active in foreclosure prevention. John Taylor, president and chief executive of the National Community Reinvestment Coalition, said: “We hope this innovative effort inspires other mortgage servicers to follow suit.”
Is this the long-awaited magic-wand solution to the housing crisis? Not likely. But if major banks and servicers come out with their own versions — and, better yet, the Obama administration tells servicers to include the idea in their tool kits — then the impact could be much more powerful.