Obama's Loan Modification Plan Simplified

As part of his 2009 economic recovery package, President Barack Obama has introduced a plan to rescue and revive the troubled housing market. Called the Homeowner Affordability and Stability Plan (HASP), the plan argues that modifying and restructuring existing distressed mortgages will keep struggling borrowers in their homes and stop the downward spiral of property values by keeping homes from entering foreclosure. There is $75 billion dedicated to this plan, and below are the key details about this plan:

First off, HASP focuses on "mortgage payments" rather than "property values" since it argues that homeowners will continue to stay in their homes, even as values decline, as long as they can make their monthly payments. Many economists agree that foreclosures happen mostly because borrowers can’t pay the monthly payment that they agreed to pay. To that end, Obama's plan requires the participating loan servicers to reduce monthly mortgage payments to less than 38% of the borrower's gross monthly income. The government would then pick up the rest of the tab. The loan servicer can use several methods to achieve lowering of the payment such as: reduce the interest rate to as low as 2%, extend the terms of the loan (possibly up to 40 years), forebear loan principal at no interest. In an attempt to create incentives participation, loan servicers will be paid $1,000 for each modification and will get an additional $1,000/year for up to 3 years, as long as the mortgage payments are paid on time . Borrowers can also get up to $1,000 off the principal balance for up to 5 years if they make their payments on time.

Because HASP is designed for responsible homeowners who just happen to have been plagued by the slump in the housing market, only owner-occupied, primary residences with mortgage balances of up to $729,750 are eligible. The plan also helps those homeowners who have been hit by a "financial hardship" such as a loss of income or a mortgage rate increase which have put them at risk of default. To qualify, each borrower must sign an affidavit of financial hardship and verify their income with documents. Although second liens such as home equity loans or HELOCs are also being addressed by the plan by providing further incentives, key details on this component of the plan are still somewhat unclear.

At the end of the day, it is all about the economic interest of the investor. Servicers typically run the Net Present Value test to determine whether there will be more cash flow to the investor if the loan is modified or not. In this case, government is helping to pick up the slack where there is shortfall of cash.

Loan modification agreements come in different forms but quite frequently they involve the reduction of mortgage's interest rate for a specified period of time so the homeowner can continue to make payments and stay in the home. Loans can also be modified so they have a longer amortization term (e.g. 40 year instead of 30 year) which will cause the payments to decrease. Principal writedowns are rare, but they do indeed happen where the bank actually writes down some of the principal amount.

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