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Wednesday, March 4, 2009

Assessing the President's Loan Modification Plan II

Those of us waiting until today for guidance on exactly who will and won't qualify for loan modifications under the President's plan were in fact disappointed. In fact, the President presented very little new from his initial announcement two weeks ago. As far as guidance, here is all that the administration offered.

The administration, launching what it calls the "Making Home Affordable" initiative, said that borrowers will have to provide their most recent tax return and two pay stubs, as well as an "affidavit of financial hardship" to qualify for the $75 billion loan modification program, which runs through 2012.

To the outside world, this might be some sort of revelation, however loan modifications have long required pay stubs, tax returns, and a hardship letter. As such, all that we know about this program we already knew when it was first introduced a few weeks ago.

In other words, anyone that comes up with a good enough sob story will be able to have the terms on their loan reduced. After all, that is what a hardship affidavit really is. All it is, is a statement of why you are having difficulties paying your current loan. Whether it is a loss of income, an increase in mortgage rate, or any other increase in payment, such a scenario has the real opportunity for passing as hardship.

As such, any business owner would likely qualify. Anyone working on commission would qualify. Anyone who has seen their bonus decline would qualify. Certainly, anyone that has had to take a less paying job would qualify. Furthermore, all borrowers that took out ADJUSTABLE rate mortgages, incuding Option Arms, would qualify. It's furthermore possible for those that have seen the interest rate on their credit cards to qualify. Anyone that owns investment properties could also qualify if they can show the rent they charge has gone down. The problem with this plan is that term "hardship" is nebulous. It essentially means that you show the bank a sob story and the bank rewards you with a better loan.

This program will last for about three and a half years and you can bet as those that navigate it start to understand how it works, the abuse will become serious. Quantifying hardship comes down to maximizing debts and minimizing income and both of those are easily manipulated by those that are enterprising and unscrupulous.

Make no mistake, this plan will reward an awful lot of folks that don't deserve. Many of those in trouble took out ADJUSTABLE rate mortgages, and since their payments are almost always higher that implicitly qualifies them. These ADJUSTABLE rate mortgages were normally anywhere from a half a percent to a full percent lower than the equivalent fixed rate. More often than not, these borrowers took on these ADJUSTABLE rate mortgage because they were seduced by the lower rate. They took a gamble and they were about to lose. That is until the President stepped in to save them from themselves. The real suckers in this plan are all those folks that took on a higher rate because that rate was fixed. They will inherently have a much more difficult time qualifying, and so it is their prudence that is in fact punished.

Small business owners and commissioned folks are also huge winners. They have never before been rewarded for a downturn. Not anymore, now the President will give them a lower rate because their income has decreased, even though such is the risk in any such field.

The biggest losers are those who have steller credit profiles. They won't qualify. In fact, they will likely come to find out that even with near historically low rates, they won't get nearly as good a rate as those that are less credit worthy then them.

The biggest loser is the American economy though. Loan modifications have a history of failure. They had near 50% defaults in 2008. Nothing in this plan will alter the manner in which they are decided. In fact, government subsidies will only mean that banks will be even less careful in approving these modifications. As such, will soon have a mass of new loans at outrageously low rates with outrageously high default percentages. Such a lethal combination is something our already weak banking system will not be able to withstand. This will likely perpetuate this downturn into something truly catastrophic, and make a horrible situation far worse.


Anonymous said...

Does a loan modification have any negative ramifications for one's credit rating? If not, I can't see any reason why anyone wouldn't at least try to get something from their bank, given the current environment of handouts.

mike volpe said...

I don't want to speak out of turn, however from everyone I have spoken to, everyone has told me that there is no negative ramification.

Anonymous said...

What is your take if someone is both a small business owner and has excellent credit? And initially got into thier loan via stated income? Not to mention Adjussted Gross income is pathetically low due to write offs - I mean a front end ratio that is not even on the charts, say, 150%.