About Government Refinance and Home Purchase Programs

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With the HOPE for Homeowners (H4H) program turning out to be a total flop so far the federal government is looking into other ways to stem the tide of home foreclosures in the US in an attempt the shore up the economy. One of those alternatives that has been in vogue in the recent month or two is to have the government give incentive to banks to offer loan modifications to borrowers in trouble. The idea as we understand it is that some taxpayer money would be set aside as insurance of sorts so that if borrowers still default after their loan is modified the government would help the banks with some of the costs associated with that. But a recent study is calling the wisdom of subsidizing loan modifications as as well. Here are some quotes from a recent CNNmoney.com article on the subject:

More than half of delinquent homeowners whose mortgages were modified earlier this year ended up redefaulting within six months, a top bank regulator said Monday.

Some 53% of borrowers with loans modified in the first three months of 2008 and 51% of those with loans modified in the second quarter could not keep up with payments within six months, according to U.S. Comptroller John Dugan, who spoke at a housing conference.

So if more than half of people who get a loan modification will default anyway some are asking if taxpayer money should be used at all in this process.

There are a couple of things to keep in mind with these numbers.

1. Defaulting only means that the homeowner has at least one late payment on the mortgage. We should not confuse “default” with “foreclose”. The number of people who will actually have to foreclose is likely a small fraction of that 53%.
2. We have no data on the type of loan modifications that were given in this study. In many cases banks have given modifications that were only slightly better than the original loan so the lender took what they could get even though it was not enough. This would not be allowed for government backed modification programs.

So while the numbers look bad on the surface, we need to be sure we are looking below the surface as well.

Here are some more quotes from the article on the plan backed by Sheila Bair, head of the FDIC:

Modifications that include an interest rate reduction have a 15% redefault rate, said Bair, citing a recent Credit Suisse study.

Last month, Bair unveiled a plan to address the foreclosure crisis by modifying loans to as low as 31% of a borrower’s gross monthly income. This could be done by setting interest rates to as low as 3% or extending loan terms to 40 years. Principal could also be deferred free of interest to the end of the loan.

To entice servicers and investors to participate, Bair’s plan calls for the government would share up to 50% of losses should the loan redefault. But that guarantee only kicks in after the borrower has made six monthly payments to better ensure the mortgage modification is sustainable long-term. It would cost $24.4 billion, which Bair has said could come from the rescue funds.

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