Treasury Department Mortgage Relief Plan: Who It Affects and What’s Next

The Bush administration on Dec. 6 announced a voluntary plan to help some borrowers with subprime adjustable-rate mortgages. The apparent intent of the plan is to reduce the number of imminent foreclosures by helping borrowers who are not likely candidates for refinancings due to low credit scores, lack of equity and poor payment histories.

Perhaps the most important point that can be made about the plan is that it does not have the force of law. This is probably due to the fact that there are constitutional and statutory realities involved with any effort to make a plan binding. It is far from clear whether the government could impose any type of mandatory plan applicable to existing loans due to limitations imposed by the Fifth Amendment to the U.S. Constitution. In addition, the plan’s proposed loan modification provisions only apply to a relatively small subset of loans.

Plan is joint initiative to streamline refinance process

The plan is a set of principles or guidelines prepared by the American Securitization Forum and endorsed by representatives of various federal agencies and representatives from the Hope Now alliance, Mortgage Bankers Association and the Housing Policy Council. Treasury Department officials helped broker the agreement.

Plan guidelines are designed to streamline the process of refinancing and modifying certain subprime loans. This primarily private-sector initiative involves no change in law, no government mandate and no government money. Guidelines are intended to help mitigate losses to loan pools (i.e., protecting investors in the aggregate) by creating a streamlined approach for servicers to address anticipated increases in volume of defaults. The voluntary plan enables servicers to modify certain loans when appropriate.

Eligibility factors include loan type, borrower credit score

The guidelines for modifying existing loans apply to certain subprime adjustable rate mortgages (ARMs) secured by owner occupied homes. Subprime is not specifically defined in the plan. A general working definition is a borrower with a FICO score of 660 or less. To qualify for the streamlined approach set out in the plan, borrowers will have to have a credit score of less than 660 and no more than 10 percent higher than the score at origination. Covered subprime ARMs are first lien subprime residential adjustable rate mortgage loans that have an initial fixed rate period of 36 months or less and that:

a. were originated between January 1, 2005, and July 31, 2007;

b. are included in securitized pools; and

c. have an initial interest rate reset between January 1, 2008, and July 31, 2010
(with a payment that will increase by more than 10 percent).

To be eligible for modification, subprime ARMs must also be current (i.e., not more than 30 days delinquent and not more than 60 days delinquent on more than one payment during the preceding 12 months). Such loans are likely to have relatively little equity (i.e., first lien loan to value greater than 97 percent).

The guidelines do not apply to loans that are not in securitized pools. The guidelines also do not apply to fixed-rate mortgages, ARMs that have already reset or delinquent loans—even if such loans are in securitized pools.

Servicers still bound by applicable laws

Servicers on non-securitized loans are not subject to the guidelines.

Servicers of loans in securitized pools are still bound by applicable laws and contracts. So, servicers for securitized pools of loans must not take any action that is prohibited by the applicable pooling or servicing agreement or other applicable securitization documents. Servicers implementing the guidelines would be expected to contact borrowers approximately 120 days before a borrower’s reset date.

Covered servicers have not been granted immunity from lawsuits by investors. Some servicers have expressed concerns regarding possible legal actions by investors if the servicers undertake loan modifications. However, the guidelines appear to be consistent with general contractual terms and industry best practices.

Regulators have expressed concern about any sort of statutory protections based on the apparent belief that attempting to negotiate and enact such protections would delay loan modification activity and could have an adverse impact on markets by making investors skittish about the reliability of contractual obligations.

Additional regulatory actions likely

It appears consumer groups will push for more action and broader coverage. It is not clear whether regulatory agencies (primarily bank regulators but also individual states) expect similar actions with regard to entities and loans not subject to the guidelines. California has already announced an agreement with several large loan servicers, including Countrywide and GMAC, to streamline modification procedures for certain subprime borrowers. It does not appear the California agreement is limited to securitized loan pools.

The FDIC chairman is advocating systematic approach to restructuring for subprime loans on the theory that it would free up servicer resources to work with troubled borrowers who will require individualized solutions. Implications of the FDIC position are unclear in light of the announcement of the plan.

In addition, some legislators have proposed civil money penalties for originators, assignees or securitizers that engage in a pattern or practice of originating, assigning or securitizing mortgage loans that violate specified standards. Presumably, such requirements would not apply retroactively.