Is HOPE hopeless?
When lenders appeared before Congress on Sept. 17 and were less than enthusiastic about utilizing the new Federal Housing Administration (FHA) HOPE for Homeowners (H4H) program, I really thought that they were grandstanding a bit and trying to put themselves in a position to gain better terms for the program. The lenders made statements such as the following ...
"For many investors, the program may not be viewed as an
attractive option, especially when our experience shows we can
achieve relatively low rates of re-default when we modify a loan
through a rate reduction that lowers the borrower's monthly payment
to an affordable level."
—Marguerite Sheehan, Senior Vice President, JPMorgan Chase
But on closer examination, the fact that lenders are willing to go it alone without FHA is right on the mark. As a matter of fact, I find that theH4H program is a bad deal for homeowners and lenders when compared to a lender direct loan modification. Why is this the case?
First, let's look at the lender's position in the H4H transaction:
•The lender has to bring the principal down to 90 percent of the current value of the home. Under a lender-direct modification, the lender has no such obligation. There is no reason that the reduction of principal needs to be less than 100 percent of the current value of the home.
•Actually, considering the fact that the mortgage insurance premium and closing costs of the new FHA loan are likely to be included in the new loan amount, the reduction of principal is more likely to be down to 85 percent of the current value.
•The new loan amount is limited to $550,440; therefore, larger loan amounts are not able to be refinanced under this program. Obviously, there is no such restriction with a lender direct modification.
•The property must be the primary residence of the homeowner and the homeowner must own only one property. Again, there is no such restriction with a lender direct modification.
Now let's look at the position of a homeowner in the H4H transaction. At first glance, it appears that the homeowner achieves a good deal because the lender is forced to bring the principal balance down to around 85 percent of the mortgage amount under the program. However, there are several other considerations that serve to mitigate these gains:
•Under the H4H program, because a new loan is originated, the interest rate on the new loan is likely to be at market. Under a direct lender loan modification, the homeowner may be able to negotiate a below market rate. As an example, if the rate is reduced from six percent to five percent, the payment will represent a savings of almost four percent of the loan amount over a five-year period.
•In addition to the option of offering a lower rate, the FHA program also requires that the new loan be a 30-year, fixed-rate. However, under a direct modification, the lender can offer a 40-year, fixed-rate, and thus save the homeowner another 3.3 percent over a five-year period.
•On the new FHA loan, the homeowner is required to pay a three percent upfront mortgage insurance premium, as well as a 1.5 percent monthly premium. That is a cost of more than 10 percent over a five-year period! There is no insurance required for a direct lender modification.
•In addition to the mortgage insurance premium, under the FHA program, the homeowner will have to pay traditional closing costs, which could be as much as three percent of the loan amount. This can be financed out-of-pocket—through a higher interest rate or by a further curtailment of principal by the lender. By comparison, closing costs for direct lender modification are minimal.
•To make matters even more restrictive for the homeowner, a second mortgage cannot be placed on the new mortgage for the five-year period after the FHA H4H loan is originated.
Here is the one fact that really could be the most important drawback of the FHA program for homeowners: A great portion of equity gained on the home in the future is shared with FHA. Therefore, there is no upside to the lender and a reduced upside to the homeowner. This shared equity starts at 100 percent to FHA during the first year and will remain at a minimum of 50 percent to FHA from five years until the duration of the mortgage. In other words, if the homeowner holds a $300,000 home for 10 years and there is a gain in value of 40 percent (this is approximately 3.5 percent per year, which would barely keep appreciation in line with inflation), then FHA would have a payday of $60,000 and the homeowner is a clear loser of another 20 percent of the value of the overall transaction.
Bottom line, in percentage terms, the lender loses up to 15 percent upfront and what looks like a 15 percent gain to the homeowner can easily turn into a loss of more than 30 percent to the homeowner. I can't think of more of a "lose-lose" situation.
There are obviously good reasons for the lender to focus on modifying the loans themselves, rather than relying on the H4H program. Costs are minimal and there is more flexibility in the final terms as the interest rate, loan type, principal balance and even the way the loan is reported on the credit report can all be up for negotiation. With a direct lender loan modification, there are typically no restrictions, such as sharing equity or placing a second mortgage on the property in the future.
And I believe that it is the responsibility of a loan officer to help direct his clients in the right way in this regard. The good news is that many loan officers are originating loan modifications, and it has turned into an income source as important as originating a new loan.
If you would like more information about loan modifications so that you can educate your clients and possibly add this as a service, do not hesitate to e-mail me at [email protected] and I will forward to you a slide presentation with an accompanying audio seminar.
Dave Hershman is a top speaker and leading author in the mortgage industry with seven books—including two best sellers for the Mortgage Bankers Association of America. He also delivers his targeted "Joint Venture/In-House Loan Officer Training" for the industry. For more information, call (800) 581-5678 or e-mail [email protected].