When people in the media or government write about the housing crisis, the numbers are either so macro as to be unfathomable (trillions of dollars) or so micro they focus on the plight of a single family. I had trouble comprehending the scope of the problem until I read a report by The Congressional Oversight Panel (“the Panel”). They used the following analogy to help put the current crisis facing America in perspective:
More Americans are losing their home in foreclosure each month than left New Orleans after Hurricane Katrina. In 2008 alone, the foreclosure crisis has had the force of a dozen Hurricane Katrinas.
This translates into nearly 2,900 American families losing their home each day.In their report, Foreclosure Crisis: Working Toward a Solution, the Panel outlines a checklist for successful loan modifications. While written to address systemic problems arising from the mass securitization of mortgages, the checklist still provides guidelines for credit unions that are facing the need to modify loans they hold in portfolio.
- Does your plan result in modifications that create affordable monthly payments?
- Does the plan deal with negative equity?
- Does the plan address junior mortgages?
- Does the plan overcome obstacles in existing pooling and servicing agreements (PSAs) that may prevent modifications?
- Does the plan counteract mortgage servicer incentives not to engage in modifications?
- Does the plan provide adequate outreach to homeowners?
- Can the plan be scaled up quickly to deal with millions of mortgages?
- Will the plan have widespread participation by lenders and servicers?
Let’s take a look at four of these items and how they are relevant to credit unions holding potentially delinquent loans on their balance sheet.
- Affordable Monthly Payments
Estimates from various studies on loan modifications put the range of modifications that actually lowered a person’s monthly payment from a high of 43% to a low of just 20%. It is no wonder that many modification don’t work! The voluntary government programs provide varying guidelines that tell servicers to aim for anywhere from 31% front-end (principle, interest, taxes & insurance) debt to income (DTI) to a high of 38%. However, the GSE’s own guidelines indicate an appropriate range of 25-28%.
Others argue for a more imprecise but realistic measure using back-end DTI which factors all monthly debt in to the question of affordability. In cases where credit unions have multiple products and services per member, they can get a more accurate estimate of back-end DTI and consider how to restructure a member’s entire relationship, not just the mortgage one.
- Negative Equity
Although the data is incomplete, two studies show that negative equity is the number one determinant of the likelihood of foreclosure. And in some cases, this is the economically rational course of action for a homeowner if the costs associated with a credit default are less than the length of time until equity returns in the property. Where there is a glimmer of hope for credit unions is that the data behind these findings is incomplete. The report points out that we don’t know if it is the negative equity alone or if there are other contributing factors (like falsified income at the time of origination) that are the root causes. For credit unions that engaged in thorough underwriting, there is hope that members will see the value of continuing to pay an underwater mortgage and/or reach another agreement with the credit union rather than just walk away from a property.
- Adequate Outreach
Most modification programs do not reach out to borrowers until they are in default, when they are already scared and reluctant to deal with “debt collectors.” There has also been a prevalence of modification scams where people pay for assistance they can get for free under government or community programs. Therefore, it is critical for credit unions to “extend the olive branch” early by making their desire to help members in need—and before they become delinquent. I covered this topic in Reaching Members Who Don't Know How to Ask for Help.
- Can you scale?
Here the challenge is that in “normal economic times” (however one might define that), delinquent loans are handled by a collections department with people trained with a specific set of skills. Modifications are an altogether different beast that require more time, effort and understanding than a delinquent loan. Therefore, it is important to act early and hire more people than you might think are necessary to handle modification requests. It’s also important to find the right skill sets. Some credit unions have seen their modification programs grow to 10 times their previous collections department in size.