"'Tis always morning somewhere."
(Longfellow)
"Nothing in life is to be feared. It is only to be understood."
(Madam Curie)
Longfellow & Curie realized the importance of a positive view of daily life.
Moving forward is more important than looking back.
The 2007 mortgage crises is causing a substantial disruption in the flow of mortgage funds to real estate home borrowers. This mortgage crises is directly related to the aggressive Adjustable Rate Mortgage (ARM) loan programs offered by mortgage lenders beginning 2002. ARM loan programs were being offered to all mortgage loan borrowers.
The current news story focuses on "Sub-Prime" ARM borrowers, but all ARM borrowers have unstable monthly ARM payments.
Each delinquent ARM borrower effects many investors. Any ARM delinquent loan solution must focus on refinancing the ARM loan into a thirty year fixed rate loan. A secondary market must be established to purchase the new refinanced fixed rate loan. FNMA and FHLMC can fill this need.
Federal reserve monetary policy began easing in 2001 and in June of 2003 the federal funds rate reached a low of 1.0%. At the same time, the mortgage industry's short term borrowing cost reached an all time low. All ARM loans are tied to the lender's short term borrowing cost and referred to as the "Index". The index is suppose to reflect the actual cost of borrowing money from commercial lenders.
Mortgage investors need to make a profit, so a charge must be added to the index to reflect the investment risk (yield return) and the cost of servicing the loan. This charge is known as a "Margin". The margin is fixed for the life of the loan, so as the index moves up or down, the ARM monthly payment will move up or down. ARM loans have adjustment and life caps that are unique to each ARM loan.
Adding the margin to the index is called the Fully Indexed Rate (FIR).
ARM mortgage investor are suffering excessive financial losses due to the homeowner's inability to make the FIR monthly ARM payment due to increases in short term borrowing cost.
The delinquent borrower with a fixed rate mortgage is not confronted with monthly P&I payment changes. Borrowers facing foreclosure, that have fixed rate mortgages, have other non payment issues in play effecting their ability to make the monthly fixed rate payment.
Fixed rate loans are not eligible for the ARM workout solution.
It was the potential ARM monthly payment increases that were not considered by ARM borrowers at time of loan application. Many ARM borrowers did not understand the impact of rising short term borrowing cost on future monthly ARM payments.
For all marginal home buyers using ARM loan programs, the positive was achieving elusive home ownership. Without the ARM sub-prime loan programs, millions of home buyers would have never owned a home and never experienced the awful impact of foreclosure on the family psyche: the happy moment turned ugly.
Who is to blame for this catastrophic breakdown in the ARM borrower's ability to make the monthly mortgage payment? Congress, greedy financial markets or bad consumer decisions? Did the passage of the Community Reinvestment Act - enacted by congress to help low income borrowers in low income neighborhoods - contribute to the current foreclosure mess?
Does it really matter who is responsible for a problem that needs a solution?
In this article I'm going to present a simple solution to a complex financial market problem.
All mortgage borrowers make payments to a loan servicer. Sometimes the servicer is the original lender who has transferred all beneficial financial interest to one or more investors and collects a fee for servicing the mortgage. After deducting the servicing fee, the servicer transfers the remaining portion of the payment to the investor. Mortgage Backed Securities (MBS) holders represent an investor in this scenario.
One loan can have many investors and therein lies the problem. The servicer can not make a unilateral decision concerning a delinquent mortgage loan. The only way the servicer can help the delinquent borrower is to agree to refinance the loan, pay off investors and the financial world continues to function.
Refinancing delinquent borrowers is not possible due to impaired credit and property values that do not support the loan request. There is no secondary mortgage market for this type of distressed loan refinance.
After loan closing, payment increases caught the ARM borrower by surprise. The type of ARM loan chosen at time of loan application was not understood until sometime after loan closing. As an example, at a future date (after loan closing), negative amortizing (POARM) loans could have loan balances greater than the original loan balance and a fully indexed rate of 7.5% to 8.5%. Three years after closing, the terms of this loan could force the borrowers to make payments based on 115 to 125% of the original loan balance at the higher fully indexed rate. The increased mortgage payment and subsequent strain on family income creates the mortgage delinquency.
The fully indexed rate (FIR) is the key to understanding the current default situation. AAA ARM borrowers probably accepted an index (LIBOR, 12 MTA or 11th district cost of funds "COFI") plus a 2.75% or higher margin. Many of these borrowers are delinquent because they did not understand the consequences that went with the ARM loan decision. Adjustment caps dampened the payment increase hit, but eventually the FIR caused the payment to exceed 75% of the family's net monthly income.
The sub prime borrower was unable to negotiate any loan terms with the lender and was offered a "take it or leave it" ARM loan program. This type of borrower accepted a fixed rate from 5.875% to 7.500% or greater for a period of two or three years that converted to a semi-annual ARM with adjustments caps of 1.0% to 1.5%. The six month LIBOR was the preferred lender index with margins of 3.5% to 4.5% or greater. The fully indexed LIBOR interest rate on this type of ARM loan could be as high as 12.5% depending on the margin identified in the mortgage note.
Borrower ARM education was lacking at the time the delinquent borrower applied for the loan. Granted, RESPA required the lender to fully disclose the terms of the real estate ARM loan and deliver to the ARM applicant a pamphlet entitled "COMSUMER HANDBOOK ON ADJUSTABLE RATE MORTGAGES", but many of the lender representatives did not understand the ARM loan parameters or they had other reasons for preventing the borrower from discovering the loan terms and future impact on monthly income.
The ARM borrower's inability to make the monthly payment effects future borrower(s), loan servicers, banks, investors and financial global markets. The impact of two (2) to five (5) million U.S. foreclosures on global financial institution balance sheets could reach two trillion dollars ($2,000,000,000,000) in losses by the end of 2008.
Many financial institutions and loan servicers will be facing 2008 bankruptcy decisions.
Simply stated, all affected parties need to pitch in to solve the problem.
The solution to this financial crises is simple. Look to FNMA and FHLMC (known as government sponsored entities or GSE) to help solve this problem. FNMA & FHLMC's approved seller/servicer business partners will refinance the delinquent ARM loan, if there is a secondary market for the new 30 year fixed rate loan.
FNMA/FHLMC are currently experiencing financial difficulties as of 11-26-2007, but have the financial strength to weather the storm. Congress must allow these GSEs to participate in helping the troubled homeowner move out of harm's way.
This is not a bail out, but a helping hand to the voting public.
To create a secondary market for delinquent loans, I recommend congress approve increasing FNMA and FHLMC investment cap from their current combined limit of $1.4 trillion to $2 trillion. At the same time, increase FNMA/FHLMC's loan limit from $417,000 to $625,000. I realize that OFHEO (government agency) has oversight, but if congress does not support such a move, no action will be taken.
Loan servicers do not have the financial resources to fund and retain the investment. Servicers must transfer the risk, but be willing to service the loan for a small fee (percentage).
Since 2002, many borrowers have used 80/20 loan programs and have little or no equity in their properties. Chances are there are two servicers involved with a delinquent borrower. If there is a refinance conflict between 1st & 2nd loan servicers, the lender servicing the 1st mortgage will be responsible for processing and closing the refinanced distressed loan, but only approved FNMA/FHLMC seller servicers would be eligible to participate in this distress borrower program.
Only owner occupied properties will be eligible for refinance assistance and must meet FNMA/FHLMC home loan guidelines.
This refinance effort would be limited to existing delinquent ARM borrowers.
Not all delinquent ARM borrowers will qualify for a refinance opportunity and there will be tears.
Many properties securing delinquent loans will have values less than the lien(s) against the property. Forget the appraisal requirement and refinance the loan regardless of value. This refinanced loan will be limited to 80% of the delinquent loan balance as of the date of first payment default.
The home must be in good repair and occupied by the borrower.
Creating a FNMA/FHLMC secondary mortgage market for refinanced delinquent loans will reduce the number of foreclosures and stress on the U.S. financial markets.
The loan servicer will be responsible for underwriting the delinquent borrower's loan request. This lender must verify, under the penalty of perjury, that all necessary steps have been taken to insure the current delinquent borrower has the necessary monthly income to make the new monthly payment. The lender underwriting the distressed refinance loan request must verify borrower(s) employment, stability of employment and gross monthly income. The maximum ratios should not exceed 39/45% of gross monthly income: preferred new 30 year fixed rate monthly house payment to income ratio (PITI÷gross income ) would be 35% or less.
The new payment must include property taxes and insurance.
If the borrower is responsible for making common area monthly association fees (HOA), any delinquent HOA balance must be included in the refinance loan request.
An additional incentive of $25 would be deducted from the borrower's monthly loan balance each month for direct payments to lender from borrower's checking account. There would be no penalty for early payoff (no prepayment penalty).
All reserve requirements must be waived.
The servicer must be willing to service any troubled refinance loan sold to FNMA or FHLMC for a 0.20% servicing fee. The servicer of a delinquent loan must convince the existing investor(s) to accept 80% of the balance due and forgive all interest, penalties and fees due: 80% of the investment is better than losses of 30, 40, 50 or even 100% due to foreclosure.*
* An alternative investor solution might be taking a no interest silent 2nd for 20% of delinquent
loan balance that includes a no prepayment provision.
FNMA/FHLMC would purchase from an approved Seller/Servicer all delinquent ARM loans that have been refinanced into 30 year fixed rate loans. FNMA/FHLMC would limit their required yield to 0.300% above their borrowing cost i.e. cost = 5.000% - purchase loan at 5.300%.
An additional 0.100% should be added to the interest rate as insurance against default and held in an equity account. This 0.100% should be set aside in a trust fund that would be use to reward the borrower for on time payments. After 36 months of on time payments, this 0.100% equity account would be returned to the borrower by reducing the current loan balance and reducing the interest rate by 0.100% starting with the 37th payment forward.
As an example, if FNMA/FHLMC cost are 5.200%, the GSE should offer to purchase a thirty (30) year fully amortized loan from the seller at 5.500% as long as the note's interest rate is not greater than 5.800% (0.200% servicing fee + 0.100% insurance fee). The 0.100% fee would be retained by the servicer in an escrow account and used to pay down the loan balance after 36 months of on time payments.
The 0.1% could be used as liquidated damages in the event of a second default.
All family financial decisions are based on net monthly income. By refinancing the delinquent loan into a thirty (30) year fully amortized mortgage loan, the borrower must demonstrate the ability to make the lower monthly mortgage payment.
An individual or family will not spend more than 52% - 54% of the net family income on shelter. Some frugal homeowners will spend up to 62% of net monthly income for shelter expense, but they do not have excessive credit debt.
The question is: Does the delinquent borrower have employment income?
Based on this question:
Does the borrower have the ability to repay the debt?
The key to extending a helping hand to delinquent ARM borrowers is underwriting the risk. If the borrower has the ability to make the monthly mortgage payment and demonstrates a desire to retain the home, investors will buy FNMA/FHLMC mortgage backed securities secured by these loans. FNMA/FHLMC must agree to repurchase any defaulted loan during the first 36 months of the loan's life.
In Summary:
- ARM Loan must be in default.
- Property must be owner occupied.
- Borrower must have the ability to make the new 30 year monthly payment.
- FNMA and FHLMC combined investment caps be raised to $2 Trillion.
- FNMA/FHLMC loan limits be raised to $625,000.
- FNMA/FHLMC yield return is limited to 0.300% above borrowing cost.
- Loan servicer agrees to service loan for 0.200% of loan balance.
- Borrower agrees to 0.100% equity account.
- $25/month principal reduction for automatic checking monthly payment deductions.
- New mortgage loan contains a "No Prepayment Penalty" provision.
- Loan servicer is required to underwrite the risk and certify all borrower information.
- At risk investors must agree to accept 80% of existing investment.
- At risk investors must forgive all delinquent interest and late fees.
- FNMA and FHLMC must agree to repurchase any loan that becomes delinquent.
"What's important is that one strives to achieve a goal."
(Ronald Reagan)
Helping owner occupied delinquent ARM borrowers will help the nation move forward.
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