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Feds' Mortgage Modifications: Rules Loosen Despite Defaults

After some efforts didn't exactly curb foreclosures, the feds are trying again.

They're about to launch a simplified loan modification program to lower payments in hopes of keeping homeowners in default from ending up fully in foreclosure.

How simplified? Eligible borrowers won't have to document financial hardship.

The Federal Housing Finance Administration program, called the Streamlined Modification Initiative, kicks in July 1.

Critics, such as the American Enterprise Institute's Edward Pinto, see potential for trouble.

"The government keeps moving the goal posts to make it easier and easier to qualify in order to pump up the success rate and to pump up the numbers," said Pinto, an AEI resident fellow who in the 1980s was an executive with Fannie Mae (FNMA).

The new FHFA program is a significant departure from other government modification initiatives that require documentation — such as the signature HAMP, or Home Affordable Modification Program. The FHFA, which regulates government-sponsored mortgage backers Fannie Mae and Freddie Mac (FMCC), hopes this endeavor will spur more homeowners to seek help.

The plan, announced in late March, follows a string of government efforts launched in 2009 by the Obama administration to lower mortgage payments and curtail foreclosures.

At that time, the Treasury Department earmarked $30 billion in Troubled Asset Relief Program (TARP) funds to finance HAMP and other programs.

HAMP Trouble Tally HAMP has underachieved, not coming close to helping the 3 million to 4 million potential homeowners originally targeted.

In many cases HAMP participants are re-defaulting at an "alarming rate," according to a report by the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) on April 24.

The report found that of more than 2 million borrowers that started HAMP modifications since 2009, fewer than 862,300 homeowners were still in the permanent modification program at the end of this year's first quarter, the only way they could avoid foreclosure.

Nearly 775,000 modifications were canceled in the trial period.

More than 312,500 were canceled after becoming permanent. Of those, 312,000 were re-defaults, the report says.

Cancellations involve borrowers who fail to finish a three-month trial, re-default after successfully completing the trial or after getting a permanent modification, are disqualified, or pay off their mortgage.

Nearly half of homeowners who received a modification in the third quarter of 2009 have defaulted.

SIGTARP concludes that re-defaults become likelier the longer borrowers stay in HAMP.

SIGTARP figures the Treasury Department has spent more than $7 billion in TARP on all mortgage relief programs.

The AEI's Pinto says the new modification program creates the potential for moral hazard — taking a risk without the fear of losing money — because homeowners may decide to default in order to get a modification rather than show they meet the requirements for a refinance.

FHFA said the new program seeks to fix challenges surrounding the "document collection" and servicer evaluation requirements that have stymied borrower participation in modification programs. Removing those administrative barriers "should enable significantly more borrowers to access the available options for home retention.

Under the streamlined modification plan, mortgage servicers will have to contact borrowers who are 90 days to 24 months delinquent and offer a plan to lower their payments. Eligible homeowners will receive a new loan with a fixed interest rate and a 40-year term, and they'll be able to make the modification permanent after making on-time payments during a three-month trial period.

Only loans owned or guaranteed by Fannie or Freddie qualify, and the mortgages must be at least 12 months old. The loan amount must equal 80% or more of the home's value. Loans already modified at least twice are not eligible, and the program is set to end Aug. 1, 2015.

Perks From Documentation Homeowners who participate in the streamlined program will still be encouraged to provide documentation, which could result in "additional borrower savings," according to a statement by Edward DeMarco, acting director of FHFA.

Any modification could be considered a success, given the likelihood that interest rates are lower than when borrowers got the loan, says Richard Andreano, a partner in the Washington, D.C., office of law firm Ballard Spahr.

"Even if borrowers don't take that second step to provide documentation and get a better deal, at least (the government) has achieved some level of relief for the borrower while reducing risk for Fannie and Freddie," said Andreano, a mortgage banking regulation specialist. "It's a decision that half a loaf is better than no loaf.

To some observers, the chance to modify a loan without the hassle of submitting documentation looks likely to spark intentional defaults. Strategic Default Risk Fannie and Freddie are employing "proprietary screening measures" to prevent strategic defaults, FHFA said. Criteria reviewed will include a borrower's credit score, payment history and any past modifications, an FHFA official says.

Strategic defaults still remain a real possibility to Jaret Seiberg, a managing director in the D.C. office of financial service firm Guggenheim Partners.

"Strategic defaults are generally negative for housing, negative for servicers and negative for the (government-sponsored) enterprises," he said. "They say there are safeguards in place, but strategic defaults are still a big risk.

While the new program concerns those who want to reduce the role of government in housing, it has failed to assuage some lawmakers, state officials and community activists who want more intervention. Those interests have long demanded DeMarco's ouster in light of his persistent refusal to offer a long-lasting principal reduction plan for homeowners with mortgage balances above the value of their house.

Obama on May 1 nominated Rep. Mel Watt, D-N.C., to replace DeMarco. Statements by both sides of the political spectrum on his announcement suggest Watt is apt to seek a principal-reduction policy.