Loan modification programs are not a panacea. Today we explore the provisions which allow forbearance of principal and the problems forbearance creates.
Also, are we really only 6.4% down from the peak? Have we constricted supply and lowered interest rates so much that even the ridiculous transacts?
Irvine Home Address … 2 NIGHT BLOOM Irvine, CA 92602
Resale Home Price …… $599,000
{book1}
everything that i see
there is no future for me
everything that i read
there is no future for me
no future merchandised
everything that i see
there is no future for me
Participants in loan modification programs pawn their futures. Overextended borrowers overpay for their cost of housing and promise any future equity to a lender for the privilege of continuing to use and overpay for the family home.
The Coto Housing Blog recently featured an excellent post on loan modification programs simply titled Loan Mods I used in Loan Modifications Make Payments Affordable:
The 3rd term that can modified is the principal, although under the conditions of HARP and HAMP, the principal may be foreborne, that is, the principal can be reduced for the period of the loan, but must be paid back when the house is sold, or foreclosed on, or borrowed on. … It changes a non-recourse portion of the loan into recourse.
Today, I want to explore the implications of loan forbearance with principal deferment. I recently found a great post at Housing Kaboom with a relevant anecdote for today's discussion:
Get a clue people, prices ain't coming back!
… It just amazes me how many people really do beleive prices are going to shoot right back up again. They are convinced the bubble prices were normal and that the current price point is the aberration.
The second conversation was with a person a friend introduced to me to talk about his loan mod. I'm no financial guru but I still get asked for advice. I tell em my advice is free and worth every penny!
On the surface this loan mod sounded golden. Their current loan was for for roughly $600k, an Option Arm of course. They also had a heloc for $100k that they used to pay bills, buy a car and put a back yard in (so it's all gone). They have not made a payment on the heloc in 2 years. He works in a distribution center driving a forklift, his wife is a admin assist (whatever that is). Together they make$84k (seems like a lot for those jobs but that's what he told me they made). BTW, the house is worth approx $280k, he thinks.
The original loan was a option ARM and of course they are making the min payment of $1800/mo, the payment on the heloc was $1200 but since they are not paying it I guess it doesn't matter. The only other debt payment they have is a $400/mo car payment.
Check out this loan mod offer. He gets a 25yr fixed with a payment roughly equal to his $1800/mo (before taxes). His taxes are $480/mo. So his total nut is $2280/mo or roughly 32% of his gross. Here's the kicker though, in order to make that happen they stuck a $420k forbearance on to the end of the loan (balance of the original loan, plus the reverse arm amount, plus fees and late payments). He's happy as a pig in shit. I've never seen a mod like this one and it's from some lender I've never heard of. I'm wondering if this mod is a one in a million or if they are offering up mods like this on a regular basis. If this is common then this crisis will drag on for decades as these folks default when they need to move.
I asked about what he will do if he needs or wants to move. "Oh, that will not be a problem, prices will have recovered in a few years and we will be fine". WHAT?? Are you freeking kidding me. You think a tract home in So. Corona on a postage stamps sized lot will be worth $700k in a few years. His new total loan amount is for $100k more than peak prices AND he still owes the heloc. He is trapped in a cave of debt and the foreclosure monster is just waiting for him to pop his head out.
Ponder for a moment what loan forbearance with principal deferment accomplishes;
- The principal is immediately increased. For those hoping appreciation will save them, this act raises the bar appreciation must hurdle.
- Negative Amortization adds to principal. During the temporary payment period — which the people in the example above will treat as permanent — the shortfall for interest is either added to principal or directly subsidized by US taxpayers.
-
The larger principal amount increases interest payments. At some point the interest rate subsidies will end, and borrowers will be forced to make fully amortized payments on a debt they could never afford. The exploding Option ARM is embedded into the loan modification agreement.
In short, no homeowner is going to see a dime in equity in their lifetime, and only their false hopes keep them paying on the loan.
I discussed the implications of this kind of lending solution back in April of 2007 in How Homedebtors Could Avoid Foreclosure. Let's review some of the highlights:
There is no way to effectively restructure payments when a borrower cannot even afford to pay the interest on the debt. Lenders cannot lower interest rates to near zero because then they will lose money on the loan. Any borrower who thinks the lender is actually going to forgive the debt and allow them to keep their home is really living in a fantasy world (I would wager many FBs believe this). Lenders will not take a loss on a property loan and allow borrowers to keep the home: it's as simple as that.
As much as it pains me to write this, there is a short to medium term solution to the foreclosure problem: convert part of the mortgage to a zero coupon bond. For those of you not steeped in finance, a zero coupon bond is a bond which does not make periodic interest payments. Think of it a zero amortization loan. You don't pay either the interest or the principal, and both accumulate for the life of the loan. The loan would be due upon the sale of the house.
Here is how it would work for our typical homedebtor: Assume our financial genius utilized 100% financing and took out a $500,000 interest-only mortgage with a 2% teaser rate that is due to adjust to 6%. Let's further assume his real income (not what he reported on his liar loan) could support a $1,500 payment on a $250,000 conventional 30-year mortgage at 6%. The bank could convert $250,000 to a conventional mortgage, and convert the other $250,000 to a zero coupon bond at 6% due on sale. The homedebtor can now make their payment, and they get to keep their house. But here is the catch: when they sell their house, they will owe the bank a lot of money. If they sell the house in 20 years, they will owe $800,000 on the zero coupon bond note. In other words, all the equity gain on the value of the home will go to the bank.
The structure I outlined is a little different than the government's loan modification program, but the impact is substantially the same. People get so far underwater appreciation cannot save them. In the end they sell for a profit and give it to the bank.
Sounds like a panacea, doesn't it? There are some problems.
The first problem will become apparent when people start selling their houses. People are greedy. They won't want to give the bank all their equity when they sell. They will conveniently forget the debt relief and avoiding foreclosure and all the problems they had earlier. All they will see is that they sold the house for a lot more than they paid for it, and they did not make any money. And what happens when the appreciation does not match the term of the note? Do they do a short-sale 20 years down the line? This will cause a huge uproar and more calls for congressional intervention. In other words, for everyone involved the day of reckoning is merely delayed, not avoided.
Was amend-extend-pretend really a surprise to anyone? Isn't denial and delay the always the first and most easily predicted policy response?
Second, it does nothing for the affordability problem. If prices do not crash, a great many people really will be priced out forever. To solve this problem, banks will make zero coupon bonds available to everyone, and eventually everyone will have them. Think about where we will be then: we will be a society of homedebtors who have collectively agreed to give all our equity to the bank for the pride of ownership. Starts to sound a bit like Pottersville from It's a Wonderful Life. Is that the way we all want to live?
Isn't signing up an entire generation for debt slavery really what lending is about? Lending already increases house prices well beyond their all-cash value, if they added zero-coupon juice to prices they could inflate them to such a degree that only those who sign up for their lifelong debt structures can afford them.
Once lenders have (1) maximized current debt-to-income ratios that drain borrower's current cashflow and (2) issued every market participant enormous zero coupon notes that later capture all resale appreciation, lenders will have buttoned up the system and drained every resource possible from the housing market. At that point, owners will have fully converted to lifelong money renters.
Third, The zero coupon bond solution would effectively eliminate the move-up market because you won't have any equity to take with you from house to house. Unless you save money or get a big raise so you can afford a larger payment, you can't buy a more expensive home. This would result in a dramatic flattening of prices. In other words, the low end would be supported at inflated levels while the high end would stagnate or decline.
Fourth, Based on the problems above, it will be difficult to find a new equilibrium in prices. How would people figure out how much anything is worth? How would all price ranges be supported equally? Small changes in the interest rate on the zero coupon bond can make the difference between hundreds of thousands of dollars at the time of sale, particularly on a long-term hold. Does anyone think this will turn out in favor of the borrower? I suspect we would see a lot of short-sales as the banks graciously agree to take all the gains and forgive the rest of the debt. This takes us back to our first problem with angry, greedy sellers.
Finally, I think this is only a short to medium term solution to the foreclosure problem. For as much as we are addicted to credit in this country, there is a point where people will say "enough is enough." When a house fails to have any investment value, people will not be so excited about home ownership. People can blather on about pride of ownership all they want, but people want to make money on selling their houses. Inflated valuations are only supported by greed. If home ownership becomes less desirable, prices will end up falling back to their rental equivalent value because the demand will not be there. In the long run, we would end up with prices where they should be anyway, it would just be a much more prolonged and painful journey.
My views have not substantially changed in the three years since I wrote the above. The circumstances are what they are, and to the extent loan modifications with principal deferment occurs is the degree to which we will have the problems outlined.
As you are aware, from my statements in Housing Guru Calls for Principal Reductions, "No twist of logic or compelling narrative is going to remove the moral hazard; principal reductions to restore equity are wrong, and I will speak out against them as often and as loudly as I can."
Irvine Home Address … 2 NIGHT BLOOM Irvine, CA 92602
Resale Home Price … $599,000
Income Requirement ……. $125,871
Down Payment Needed … $119,800
20% Down Conventional
Home Purchase Price … $640,000
Home Purchase Date …. 4/19/2006
Net Gain (Loss) ………. $(76,940)
Percent Change ………. -6.4%
Annual Appreciation … -1.7%
Mortgage Interest Rate ………. 5.13%
Monthly Mortgage Payment … $2,611
Monthly Cash Outlays …..….… $3,480
Monthly Cost of Ownership … $2,780
Property Details for 2 NIGHT BLOOM Irvine, CA 92602
Beds 3
Baths 2 full 1 part baths
Home Size 1,550 sq ft
($386 / sq ft)
Lot Size n/a
Year Built 2006
Days on Market 4
Listing Updated 2/17/2010
MLS Number S605682
Property Type Condominium, Residential
Community Northwood
Tract Merc
Desirable Detached home with great floor plan. Spacious living room and dining room. Beautiful wood floor in 1st floor. Gourmet kitchen with CORIAN counters & upgraded appliances. Romantic master suite with seperate shower & soaking tub. CROWN MOLDING, CUSTOM PAINT, LOTS OF RECESSED LIGHTING & UPGRADED STAINLESS STEEL FAUCETS. Professional landcaping backyard with fruit tree. Superb location – quiet corner lot with large green grass area at front of the house. Steps to association pool/spa & community park – 8 tennis courts, baseball & soccer fields. Close to post office, shopping center & easy access to freeway. Move-in condition. Won't last long.
seperate?
The Coto Blogger says: “I’m wondering if this mod is a one in a million or if they are offering up mods like this on a regular basis.”
Yes, this is the only “solution” for Option Arm loans (get out your calculator and try to figure any other way to keep a $600,000 mortgage at an artificially low payment of $1800, which is clearly the max these folks could afford.)
And I worked for one of the largest subprime/option arm servicers, where this was common practice.
Final note: these are INTEREST BEARING deferments, not Zero Coupon, as IR suggests, so it’s even worse than it sounds.
I hope they never offer actual principle reductions… It’s just not fair to the hardworking, responsible taxpayer.
I think that what IR means by Zero Coupon is you do not need to pay interest during the term, only at the end. Zero Coupon does not mean zero interest.
Just remembered that we were doing the principle deferral as NON-interest bearing. It was a similar procedure (which was prefered by the lender) to create a balloon and that would include defered interst. Either way… Bad solutions
HA HA HA!!!! Yes, let’s just do principal forgiveness for those corrupt crony investors and banksters, because Lord knows, THAT’S fair, and the best thing is, you and I we pay for it.
The whole system was fraud, yet not one person is being charged with crimes….you know why? Because the Fed, the U.S. Treasury, and our corrupt politicians were the ones who created the fraud.
No worries though, when a few MILLION people see their homes taken and then sold for cheap to the rich, they won’t get angry…no sir. You think one man flying his plane into a building is a statement…just wait, my guess is with the attitudes of the citizens attacking the victims and the whole system screwing every taxpayer in the behind, if it doesn’t get cleaned up there will be americans dying. The world and our enemies will laugh and say that capitalism sucks, and they are partially right, this is what UNRESTRAINED capitalism and worship of money gets you. Enjoy the sacking of America.
What do you think of principal mods in bankruptcy? This carries real hazard, as people will still be reluctant to BK. At that point, I don’t see why FC & becoming a renter would be the worst part of the BK process.
Your bigger point of mortgage mods w/o principal reduction is true and should be repeated to those running the mod programs.
What would the market be for the z-c bond? Would the bank hold it, sell it, dish it to the fed? Anyone have a wager on what they’d be worth?
I think Obama needs to realize that there are going to be a huge number of foreclosures no matter what he does. It is an unfortunate fact that is a result of the bubble. It is an unpopular and unpleasant fact, but a fact nonetheless. Putting resources towards stemming inevitable results is a waste, and we don’t have a lot to waste.
“What do you think of principal mods in bankruptcy?”
This would have two effects: (1) it would cause interest rates to go up slightly to compensate for the greater risk, and (2) it would give borrowers incentive to over borrow and hope for later cramdowns if they get in trouble — moral hazard.
It should not come as a surprise that people are willing to happily accept these modification terms.
This was the goal in the first place: allow people to rent houses from the bank and allow the debtor to call themselves a home owner.
Agreed. It’s a good deal, IMHO. As long as the monthly payment is less than the cost to rent a similiar house, they will be happy. Why wouldn’t they?
If he ever needs to sell, either prices will have recovered by then, or he’ll short sale the place (or let it go into foreclosure again). But he doesn’t have to worry about that if he plans on staying put (well, in 25 years he will, but that’s a long time from now).
The one down side is you credit. Took a hit at mod time, and will take another hit if you short sale or foreclose down the road. If down the road is 5 – 7 years from now, that is a long time with sub-standard credit.
Might be better to get it over with and rebuild your credit?
The other problem is that this family has no equity. Where will they live when they retire? I hope they manage to save some of the remaining 68% of their income to buy a retirement shack somewhere.
The debt on the house will always remain; the bank will simply take the loss on its books in 30 years or whenever it sells again, which at least dilutes the ocean of bad loans on the bank’s books. Maybe that’s all they can hope for, since TARP is running out.
Yes, but if they rented for the same nut as the payment, they would have no equity either. So on this issue we have a wash.
Lots of bubble deniers are efficient-market hypothesis believers. EMH says the price is right, all the time. That could justify high prices (think Manhattan), but not continuously RISING prices. Either new information would have to come on line, or the price yesterday was wrong.
Markets eventually (almost always) get prices right but they can (1) take a long time, and (2) overshoot steady-state, or oscillate. Treating different markets as different systems you can see that some markets, as constructed, are more prone to overshoot or oscillation. Not all negative feedback systems are stable, and many, under certain conditions become unstable positive feedback systems. An oscillating system will never reach its theoretical steady state.
Markets always get prices right, you simply need to understand the rules governing the market.
Prices were right during the bubble and prices are right now. Do you see a theme? The asset bubble will be supported by the government.
What rules changed from 2004-2005?
How many people think prices were right during the bubble?
You are missing the point.
In order to forecast market prices you need to forecast government regulation, or lack there of, market prices are always right.
During the bubble housing was affordable with creative financing; aligned with rent prices. You can say the same for modifications now.
Your point is that gov’t actions set prices, and those prices are an accurate representation of value. However, prices increased dramatically from 2003-2006. Given your ‘point’, what changes in gov’t programs happened to cause this price change?
Prices have also moved downward strongly from 2006- (SEFL is off 50% from peak, and at early naughties pricing, ignoring inflation). What gov’t actions caused that price drop?
Saying ‘market’s prices are always right’ is akin to saying ‘Anarchy is the only perfect political system.’
But you’re right of course.
That kitchen doesn’t look very upgraded to me.
IR puts it so succinctly — Government Intervention equals Unsustainable Clusterf***. Let markets work!
The markets are working as they always do, participants process the governing rules and price in value.
It’s hilarious, but for most people the definition of a free market is getting the price they want.
The reality is far different; market price is always a real reflection of rules and expectations. Feel free to complain with explitives, don’t let me stop you.
Planet, you are in denial that government intervention has kept prices inflated. I agree, houses are selling at these prices, but that doesn’t mean that prices would be at these levels today if the government would have just stayed out of the picture.
Do you think if interest rates were not kept artifically low, banks were not allowed to fix their books to carry failed assets, and had not received tons of free money from the government, that the market would look exactly the same way today? Nope, you’re wrong.
I never said we had a free market.
We haven’t seen a pure free market in our lifetime, and likely never will.
It’s best to accept that.
Don’t look now, but a similar unit at 60 Nightbloom just closed for $18,000 over its 2005 purchase price. Prices will never come back. Never.
Unsubstantiated claims like this are ridiculous. The more often you say “never” the stronger your argument becomes? Man, if these trolls had at least a high school degree one could have a normal conversation with them – how about a mandatory back to school program for realtors paid for by the commissions they make?
IR, I hope you archive all the posts and ‘astute observations’ so in 2015 we can look back and see who was wrong in their predictions, and who was REALLY wrong.
Some of your predictions on median value were off and didn’t take into account all the government intervention. I can accept that, because at least the assumptions you make in your predictions have some analysis to back them up.
How long can the gov keep the music playing? How long can the props be held in place before one of them breaks? I’m really surprised by the number of people who see an uptick in prices and say that the worst is behind us and that prices are going to keep going back up. It looks like the Kool Aid is still being mixed, only this time with more sugar!
When mortgage interest rates hit 7% sometime in the near future, I’ll bet these home prices will be lower than they are today.
This charade can’t go on forever…
Interest rates won’t be that high any time soon. Not until after the economy has fully recovered will the Fed raise interest rates significantly.
My definition of “sometime in the near future” is a few years…I would guess 3 years.
The Fed can not hold down rates indefinitely, I think rate increases will start later this year. And you are making a big assumption…that the economy will recover back to normal. I think we all agree that this “little recession” we are in is far from normal.
Anyway, I was responding to Yummyhatorade’s remark that housing in Irvine will NEVER come back to an affordable value. Those are pretty bold words…I’m sure you would agree too.
What’s “affordable”? If inflation kicks in and you go from making $100,000 a year to $150,000 and housing prices remain the same…is that affordable? The best way out I see for the nation is inflation. Crank up the dollars, pay off the debt. What’s chinese currency called again?
I’m not assuming the economy will recover any time soon. I merely said that interest rates will be kept low by the Fed until it does. If it takes ten years for the economy to recover, then interest rates will remain low for ten years.
I am aware that lenders normally have 2 options to foreclose on a property: judicial vs. non-judicial. Does anyone know what percentage of defaults are pursued by the judicial method in CA? Why would a lender choose one method over the other? Thanks in advance for any info you may be able to provide.
Try reading this post:
Foreclosure 101: Non-Judicial Foreclosure
Judicial or Non-Judicial Foreclosure
Foreclosure proceedings in most states are either Judicial or Non-Judicial at lender’s discretion. Unlike mortgages, Trust Deeds give the lender the Power of Sale at public auction if the borrower fails to repay the debt. With a Trust Deed, a lender can exercise this right without a court order using the faster and less-expensive non-judicial foreclosure.
The lender may sue the borrower for repayment of property debt in a judicial foreclosure and obtain a Deficiency Judgment which they can record as a blanket lien against all borrower property in a given jurisdiction. Lenders often will pursue judicial foreclosure and Delinquency Judgment if the amount is large and the borrower has other liquid assets the lender can take or illiquid assets the lender can encumber (look out Coastal California). Lenders greatly weaken — but do not extinguish — their claim to borrower assets in the non-judicial process. Without a judgment, lenders are merely unsecured creditors similar to credit card companies hoping to squeeze life from the insolvent.
Once a lender has decided to obtain a judicial foreclosure — a relative rarity in California so far — it enters a court process ultimately leading to a Trustee Sale and Deficiency Judgment. The non-judicial process is of most interest to us because it is a process we can follow, it is the most common, and it is a process hundreds of thousands of California borrowers are enduring.
I was under the impression that California is a “non deficiency judgment state” meaning that banks cannot recourse. What am I missing?
If CA truly has no recourse, then how does the modification described above affect that? i.e., if 250K of your loan becomes some sort of interest bearing side project that you do not pay down, but comes due upon sale of the house, can the owner walk away at that point leaving the bank with no recourse? All that seems to do is delay the inevitable, or at least string it out over a long period of time. Staggering the times at which these “zero coupon bonds” or their interest bearing siblings comes due could be the ticket out of this mess… it may prop up prices to some extent but spreads inevitable foreclosures over time.
Well, the bank would simply get the house in that situation, of course. Non-recourse just means that the bank can’t sue you for the difference in the amount of money they get if they sell the house as a REO and what you owe on it.
Also, refis are recourse, and loan mods are considered refis. Only the original first mortgage is non-recourse. Any refis or seconds are recourse.
IMHO non-legal HO, Why the loan modifications are brillant for the lenders.
1. Modify the loan to use the “modified loan” as a secondary loan with compounding interest and large payment at selling or 30 years out.
2. Primary loan is still intact. Secondary loan is paying off primary loan, so principal on the first may be stable or going down.
3. FC using primary loan (non-judical) and use secondary loan modification loan to go for unsecured debt (judical).
4. Bankster get the best of both worlds. If they can collect on the secondary, bill the cost to the FEDS or CDO them through a GSE.
Using primary loan for Trustee sale (non-judical) void the borrower’s 2 years chance to pay back or reclaim the house by paying off the judgement (rarely happens, but the deed in in semi-limbo for 2 years). The borrower would/could be stuck with paying off the possible larger second (modified) note.
BHO pre-election talked about making the new loans unforgivable as with the student loans. Anyway the unforgiven clause is entering though the back door of loan modification or foreign treaties? Some state still have on the books that the adult children are responsible for their parent’s debts (usually no longer enforced, but could be with the right judges at least for the banksters).
What was an ownership society is transforming into a homerentor society. The better plan would have been to cut and run, not extend and enslave.
Methinks the bank wants to put the $$$ on the back end so that they can claim -0- principal loss and “income” which is as phantom as the “income” Option ARM interest was. I’d hope some of the accountants who cruise the site to confirm or deny this theory.
My .02c
Soylent Green Is People
Only more accounting tricks?
Possible conversions of non-recourse to recourse loans, changing bank liability to GSE/FED liability (taxpayers stuck with the bill) and definately debt slavery. Back to calling them Master …. The return of the old Roman economical and poltical sytems.
Even upon hearing soylent green is people, they continued to munch down on the soylent green.
SGIP’s point about enslaving leads to one of the biggest downsides of the mods, IMO. The U.S. has traditionally had a very mobile workforce. This has been a great advantage because those most suited for particular jobs could easily move to take the job.
Now, the government is turning a large percentage of the population into home slaves that are unable to move if a better job pops up somewhere else. This will result in the best people suited for certain jobs not being able to take those jobs. I’ve already witnessed this many times at both my company and my wife’s company. We have been hiring the 3rd and 4th best candidates – not because our top choices didn’t want the job – but because often times the top choices could not sell their homes to make the move work.
The bright side is that us renters have a huge advantage in the job market going forward.
“convert part of the mortgage to a zero coupon bond”
Government is the only potential buyer for these zero bonds (using taxpayers or freshly printed money). I can not see any alternative.
“Same as it ever was, same as it ever was, same as it ever was, same as it ever was.”
Then it is not a solution.
Solution? They would first need to admit it’s a problem.
Once you determine who should take the hit, the solutions are simple, but there will be consequences.
A. If the investors take the hit, they may sue the issuing banks and GSE for defective products. The primary investors (banksters) can collect (end investors will be out of luck as end consumers on retail products, e.g., infant formula). The primary investors are other banksters. Laywers to benefit. Too bad for retail investors to suffer the loss.
B. If the taxpayers take the hit, the govt. will need to package the bailout, modification, or whatever it’s called to confuse the public so there’s no revolt and delay the paying until it’s too late to change. Investment banksters to benefit. Too bad for retail investors and tax payers to suffer the loss. Most likely course of action.
C. Banksters to take the hit (not likely). Bankster likely to start an internal revolt for payment and war to force payment. Military Industialist and banksters likely to benefit. People to really suffer with war. Banksters own the Democrats and Republicans.
D. Force banksters to pay and include prison. Likely a fleeing to safe countries and war or embargo against countries that force the banksters to pay. See C.
Not many good choices. BHO’s hands are tied. He just a mouth piece for the banksters. Just don’t get caught converting a non-recouse loan to a recourse loan.
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All I know is that this BS shadow inventory and lack of release on part of banks is killing Realtors and loan officers alike. Less inventory translates into less sales, which means less commissions for those involved. In current market, only Listing agents with few realtors are able to make the sale and they are barely making anything. THe whole system is corrupt including our Govt., Fed, you name it. Regardless, putting a bandaid over dead corpse is not going to prevent it from stinking. Sooner or later it will cause plague. Watchout. Second economic dip is coming! Winter 2011
Unemployment in Construction Industry hit hign 30% and Union Benches are at well above 55% so go figure!