Prospects for HAMP modifications and other foreclosure mitigation efforts in Nevada

1. Prospects for HAMP modifications and other foreclosure mitigation efforts in Nevada Morris A. Davis Department of Real Estate and Urban Land Economics Wisconsin School of Business University of Wisconsin-Madison March 5, 2010

2. How does the federal Home Affordable Modification Program (HAMP) work? HAMP offers a loan modification when it is in the financial interest of the lender. Is the investor in the loan better off if the loan is not modified --- whatever the consequences of that may be – or if the loan is modified – with the investor potentially receiving less money than the original loan stipulates? This calculation is called the present value test. This question reduces to “Is the investor better off modifying the loan or foreclosing on the house?” under simplifying assumptions.

3. Eligibility for a HAMP modification • Up to the mortgage servicer to decide who gets a modification. The servicer is supposed to act in the interests of the investor in the loan. • Major requirements for eligibility for a mod: • must have a DTI above 38 percent on the first lien prior to modification; • must be principal residence; • the size of the first lien cannot exceed a certain amount; • if unemployed, must be able to show that you are eligible for at least 9 months of UI benefits prospectively. • Must be able to document “financial hardship” though defining this is left to the servicer. I believe it would help to know how the biggest servicers on Nevada loans are defining “financial hardship.”

4. If eligible, how do you qualify for a HAMP modification ? • Program is designed to look very much like the INDYMAC/FDIC program and thus based on the subprime mortgage model where LTVs are high. • The odds of getting a modification increase with the LTV of the first lien, holding income constant. Why? A modification will always reduce the value of your loan to the investor. But, in general, the higher is the unpaid balance on the loan, the higher will be the value of the loan after modification, holding income and some other factors fixed. Since it is the difference between the value of the house at foreclosure and the value of the modified loan that is critical in the present value test, loans that start out with high LTV values have a better chance of getting a mod. • Also, for any given LTV ratio, the higher is your income during hardship – the better your chances of getting the modification. This is because the mod requires that the payments not start out at more than 31 percent of income. The higher the income, the bigger the payment stream to the investor.

5. Qualifying for a HAMP modification (cont.) • It is the first lien that matters. If a borrower took out a second mortgage, or a home line of equity, or the like, they may not fare as well as the guy who has only a first lien. • When the LTV gets as high as 250 or so, the odds of getting a modification start to fall because there is some expectation that with so much negative equity, the borrower will redefault. • However, you don’t need an LTV of 100 or more to get a modification. First, the V in LTV will take into account the fact that the foreclosure price of the house is well below what the market price would be if the house sale was not a foreclosure. This so-called REO discount likely very high in Nevada. So even someone who bought a house years ago and has paid down their mortgage by a sizeable amount ought to have a fair chance of getting a modification in NEVADA.

6. Who is less likely to qualify for a HAMP modification? • Borrowers with very modest LTVs on their first lien (either because they have paid down the loan balance over time or because they have a second lien). • Borrowers who have low income in hardship and, at the same time, have relatively low LTVs on the first lien. • This suggests that borrowers who have lost their jobs or have otherwise suffered a large adverse hit to income and have also been homeowners for a long enough time to have paid down a substantial portion of the loan are likely not to be offered HAMP mods.

7. What does this mean for Nevada? • Nevada residents might be expected to have higher LTV ratios than in most parts of the country and thus be prime candidates for HAMP mods. • Nevada housing growth exceeded that in most parts of the country in recent years so its mortgages are of more recent vintage and less likely to have been paid down. • Nevada house prices have fallen more steeply than elsewhere. • Why might residents not qualify for HAMP? • The home is owned by an investor or is a second residence • the unpaid principal balance is over $729,000 on a single family house • An unemployed worker (if the primary worker) who cannot prove that he is eligible for UI benefits for at least 9 months going forward. • A borrower heavily indebted but only when the second lien is included. Many people took out second liens . Some people did this at the time of origination (piggyback loans) to qualify for Fannie and Freddie conforming mortgages. Others did so later.

8. Reasons why residents may not qualify for HAMP (cont.) • Not able to establish “financial hardship”? Job loss, loss of overtime pay, divorce, medical episodes all qualify. Even a rate reset on an ARM may qualify as financial hardship. • An LTV that is too high (somewhere around 250 or so) or an LTV that is low enough that statistically improbable that the borrower will go into default. • Is the loan an FHA loan? The FHA has its own rules for a mod, similar but not exact to HAMP. • Could the second lien holder be blocking the mod on the first lien? • The mortgage servicer may not participate in HAMP. Or, if the loan is in a private pool (where the loans are not insured by Fannie or Freddie) , the Pooling and Servicing Agreement governing that pool may prohibit any modifications.

9. What can Nevada do? • Nevada might provide help to those who are not eligible or don’t qualify for HAMP but nevertheless helping them would reduce foreclosures. • The two groups of owner-occupiers unlikely to qualify for HAMP are those who have lost jobs and have relatively low LTVs, and those whose LTVs are so high that they would likely redefault on a mod. There may be good reason to help others also. • Help for the first group could follow the Wisconsin plan or the Boston Fed plan. http://www.bos.frb.org/economic/ppb/2009/ppb091.htm and http://www.bus.wisc.edu/realestate/wi-fur A combination of temporary loans and grants to help pay mortgages while the homeowner is unemployed or for a to-be-determined period of time, whichever is shorter. Income or asset caps on the recipients of aid. A substantial grace period before the loan must be repaid , perhaps repaying the loan only when there is a transaction on the house.

10. What can Nevada do? (cont.) • Economic theory says that this first group – those with positive equity -- is not likely to default when they lose their jobs because, in normal times, they could refinance into a lower cost loan, or move to find another job, then sell their home and repay the debt. • Not likely to have such options now. Finding another job and selling a house or refinancing when you are unemployed is difficult today. • The importance of job loss to mortgage delinquencies today supported by recent study of Boston Fed (Foote et al, 2009): the important factors in increasing the delinquency probability for mortgages originated since 2005 are (1) the percentage decline in house prices in the state where the house is located and (2) the percentage point increase in the unemployment rate in the county where the house is located.

11. What can Nevada do (cont.) • The second group unlikely to get help from HAMP – those far underwater -- difficult issue. Giving help to someone with a lot of negative equity is probably not going to stem foreclosures UNLESS help in the form of principal forgiveness. Principal forgiveness introduces MORAL HAZARD. • To mitigate moral hazard of principal forgiveness, state should share in any future appreciation of the house. The borrower could do a cash-out refinance and repay part of the assistance when the house goes above water. Problem if the house is sold before the house is above water. In either case, probably not good idea for very high LTVs because the state would not likely recoup its money.