While Barack Obama's plan to rescue homeowners--originally released in mid February--included a comprehensive initiative to lower monthly mortgage payments, it failed to address in detail a related issue that threatens to undo troubled borrowers: second liens.
During the housing boom, millions of Americans took out second mortgages--such as home-equity loans--enabling them to buy property without having to come up with much down payment cash, or simply to pay for other things. Today, the government estimates that as many as half of "at-risk" mortgages have second liens as well.
Observers have noted that any successful housing rescue would have to address second liens--and not just primary mortgages. That's because any monthly savings a troubled homeowner would receive from a modification of their primary mortgage could end up going right to their second-lien bill collector if both positions aren't adjusted. For a mortgage plan designed specifically to lower monthly housing payments, this would seem counterproductive. At the same time, first lien investors--who are supposed to be repaid first--are complaining that modifying first mortgages without lowering monthly payments on second liens represents a violation of their rights, The Wall Street Journal reported.
To that end, the Treasury Department on Tuesday unveiled details of new a program to address this issue head on. The new effort is aimed at lowering monthly payments on second liens for as many as 1.5 million homeowners by offering cash payments to loan servicers (as well as borrowers).
The plan gives participating servicers two options:
1. Reduce Payments:
Making Home Affordable will share the cost with lenders of reducing payments for homeowners on second mortgages.
For amortizing loans (loans with monthly payments of interest and principal), we will share the cost of reducing the interest rate on the second mortgage to 1 percent. Participating servicers will be required to follow these steps to modify amortizing second liens:
Reduce the interest rate to 1 percent;
Extend the term of the modified second mortgage to match the term of the modified first mortgage, by amortizing the unpaid principal balance of the second lien over a term that matches the term of the modified first mortgage;
Forbear principal in the same proportion as any principal forbearance on the first lien, with the option of extinguishing principal under the Extinguishment Schedule...
For interest-only loans, we will share the cost of reducing the interest rate on the second mortgage to 2 percent. Participating servicers will be required to follow these steps to modify interest-only second liens:
Reduce the interest rate to 2 percent;
Forbear principal in the same proportion as any principal forbearance on the first lien, with the option of extinguishing principal under the Extinguishment Schedule;
2. Extinguish the lien:
As an alternative to modifying the second lien, lenders/investors will have the option to extinguish second liens in exchange for larger payments under a pre-set formula. This will allow second lien holders to target principal extinguishment to the borrowers where extinguishment is most appropriate. For loans that are more than 180 days past due at the time of the modification, the lender/investor will be paid three cents per dollar of UPB extinguished.
For the program to be successful, servicers have to participate. But whether or not they will chose to do so remains unresolved. Under the terms of the plan, servicers would receive $500 up front for each successful modification and up to $750 over three years should the primary mortgage remain current. (Borrowers, meanwhile, can get as much as $1,250 over five years knocked off the principal of their primary mortgage for making payments on time.)
Servicers will have to weigh these incentives against the possibility of conflicts--which could include legal battles--with the investors who own the mortgages. Their decision as to whether or not to participate will likely determine the fate of the program.