Hamp-ing it up

Posted by Tracy Alloway on Dec 01 14:30.

Swat teams, shaming and sanctions are just a few of the incentives now in place to force financial companies to make more mortgage modifications.
But why are such drastic measures needed?

First a quick recap:
The US government’s Home Affordable Modification Plan (Hamp) is aimed at keeping homeowners in their homes by reducing their interest payments (not so much principal). Under the programme, the US Treasury pays lenders and loan servicers a fixed fee to agree to the loan modification. The lender agrees to reduce monthly payments in a three-month ‘trial’ modification, which is then (hopefully) converted into a permanent payment reduction plan.
But the programme has gotten off to a very slow start. Critics accuse it of not leading to enough permanent mods, and of being susceptible to high redefault rates. Underwater homeowners could walk away from their homes after making one or two of the reduced interest payments.
As of September 1, there were 490,000 trial mods underway and just 1,711 permanent ones. On Monday, the US Treasury announced further steps in making more of those trial mods permanent - with the goal of having 375,000 done by the end of this year.
So why are these additional steps necessary? Why won’t banks willingly do Hamp mods?
For a start, you have the basic technicalities of the Hamp modification process. Only a certain number of mortgages are eligible in the first place, and mortgage servicers might not have the people, skills and or structural ability in place to handle a huge number of loan mods. The Hamp modification process is somewhat standardised, but it’s still resource-intensive since the mod is inevitably tailored to the individual mortgage. It’s only recently that we’ve even begun to see automation enter the picture.
The paperwork burden is also higher than for `normal’ mortgages. Homeowners can secure a three-month trial mod without proving their income, for instance, but must document their earnings to make the mod permanent — the ultimate goal of the programme. Reportedly this is one of the things preventing some Hamp trial mods from becoming permanent. So it’s not always the banks’ fault — sometimes it’s `liar loan’ applications put forth by homeowners.
But you do also have the basic reluctance of banks to modify the loan in the first place.
Banks do not necessarily make more money by entering a Hamp mod versus simply foreclosing on the property. This touches upon the redefault issue. In an environment of declining house prices, if a homeowner enters a Hamp modification and then ends up (re)defaulting months later — the bank will make less money selling on the house than it would have done before the Hamp process started.
Thus there is also a certain amount of brinkmanship involved in Hamp loan mods. The lenders and servicers do not want to initiate the Hamp mod process if they think a homeowner is a) able to make his or her current mortgage payments or b) will end up redefaulting.
This is a point very forcefully illustrated by Mandelman Matters in a piece entitled “How banks view loan modifications” :
The cost of foreclosure to your bank is going to be 30% to 50%, or even more in the worst of instances. But that’s not the most important factor to your bank . . . this is all about your bank’s degree of certainty that if they modify your loan, you won’t be back in foreclosure anytime soon, and likely never. Your bank views a loan modification as pretty close to unthinkable in the first place, so it’s unquestionable that it’s a once in a lifetime thing in their eyes. You should be too embarrassed to even ask a bank to modify a loan a second time, according to your bank. It’s almost like . . . if that happens, you’ll probably want to change your name and move to another state . . . So, you see . . . it’s a range. In order to get your loan modified, you need to fall somewhere between “Definitely won’t default again if loan reasonably modified,” and “Will self-cure the mortgage before home is actually taken back by the bank”. Get it?
Which isn’t to say banks don’t have anything to gain from entering a Hamp mod; it’s just that they have more to gain by forcing a homeowner to keep up with their current payment plan, and may have more to gain by foreclosing immediately - before the Hamp process begins.
Importantly, however, the Treasury’s Hamp programme is meant to bypass some of these ‘natural’ bank motivations. For a start, it pays servicers that participate in Hamp a fixed fee of $1,000 to $1,500 for each completed mod, plus $1,000 a year for up to three years for each borrower who remains current in the programme. It also allows banks to put their loans into non-delinquent status once the trial mod converts into permanent status - thus saving them from higher delinquency rates.
Clearly, however, given the relatively low amount of trial mods that have been undertaken, and converted into permanent status, so far - additional incentives are required. Hence the carrots and sticks now put in place by the Treasury.
On the carrot side: you have the fees for each modified mortgage, generous capital risk-weightings, and the general kudos for helping homeowners.
On the stick side: you have those possible financial penalties, the shaming, and the threat of government scrutiny of their actions.
Thus the Hamp issue looks to have become a major bugbear for the Treasury — and with good reason. Keeping people in their homes is a politically popular objective, and also one that in the eyes of the Treasury could help forestall a wave of declining houseprices caused by forced sales and foreclosures. As part of President Obama’s Making Home Affordable programme, the Hamp has also gained political prominence.
Savvy readers will of course have noticed that none of the aforementioned measures solve the redefault issue. The Treasury can effectively force banks to make more loan modifications, but if homeowners continue to walk away from their properties, the mods will have little effect on the overall US housing picture.
And that redefault issue will be a much more difficult issue for the Treasury to solve.