The financial crisis of 2008 exposed a serious deficiency in the mortgage-servicing industry: No standard approach existed to respond to homeowners who could no longer meet their loan terms but who did not want to default. The historical approach—adding penalties to the unpaid balance—only dug a deeper hole.
So in 2009 the federal government’s Making Home Affordable (MHA) program debuted to provide foreclosure alternatives. The largest operation under that umbrella was the Home Affordable Modification Program, which set standards for mortgage modifications that helped homeowners avoid default. Through these and private sector efforts, 10.5 million modification and mortgage-assistance arrangements were completed between April 2009 and May 2016, and the mortgage industry adopted certain standards that make it better equipped to manage the needs of struggling homeowners.
Yet the MHA programs will expire at the end of 2016. Private sector mortgage servicers and investors must develop their own loss-mitigation programs that will be more fitting to the post-crisis environment.
Constructing post-crisis-era solutions
To enable them in doing so, the Treasury Department, the Department of Housing and Urban Development, and the Federal Housing Finance Agency recently released a white paper, Guiding Principles For The Future Of Loss Mitigation. The paper highlights lessons learned and the best practices that should be incorporated into future loss-mitigation measures.
Through their experiences over the past seven years, the agencies identified five essential principles that should guide any new programs.
1. Accessibility. Most essentially, to benefit from foreclosure-alternative programs, homeowners must know whether they are eligible and be able to understand its requirements. Terms must be plain, and take into account the needs of homeowners with limited proficiency in English. Moreover, there should be clear avenues of recourse for homeowners who encounter difficulties.
To promote accessibility, the agencies recommend: adoption of a uniform application; third-party assistance, such as call centers and hotlines; assigning a contact person at the mortgage servicer to help a struggling homeowner throughout the process.
2. Affordability. For a mortgage-assistance program to be sustainable long-term, it must serve the needs of not only homeowners but mortgage servicers and investors. Thus any loan-modification program must consider:
• Whether a step-up modification is viable to lower the mortgage payment.
• If there are measures that can help homeowners build equity more quickly.
• Whether the borrower’s foreclosure crisis is the result of a short-term or long-term hardship and adjust solutions accordingly.
• What options are available for homeowners struggling because of circumstances unique to their location, such as natural disaster.
3. Sustainability. Because time is of the essence when foreclosure looms, the agencies recommend offering solutions that work the first time. Early intervention is key. Research indicates that modifications made as soon as difficulties arise not only reduce the risk of default, but reduce the chances that the homeowner will continue to need assistance.
In addition to early intervention that results in payment reduction, the other component of sustainability is financial counseling. The Urban Institute studied 240,000 loans over a four-year period and found that homeowners who received financial counseling were nearly twice as likely to correct their delinquency and avoid foreclosure. They were nearly three times more likely to receive a loan modification compared to those who did not receive counseling.
4. Transparency. Not only do the terms of assistance need to be clear and understandable, but information about their options and the terms of those programs should be available to all parties—and available in the public domain, the agencies recommend.
This has already been accomplished by Treasury and the GSEs, which standardized the modification process and published the requirements. They recommend that future providers follow suit.
Transparency also demands clear communications with homeowners to ensure that they understand the terms of their modifications. This points include the amount by which a payment will be reduced and for how long; whether there will be a balloon payment at the end of the modification; and what other options are available if payment reduction is not possible.
5. Accountability. Any future loan-modification program must include an appropriate level of oversight that provides protection for all parties.
The agencies are confident that if the five guiding principles are followed, the outcomes will be mutually beneficial for mortgage servicers, homeowners, and investors.
Ready for the hand-off?
When MHA expires at the end of this year, the burden of assisting struggling homeowners through loan-modification programs will transfer from the government to the mortgage-servicing industry. In handing off that duty, the agencies offered a final recommendation:
“One of the most important things we have learned from the crisis-era efforts is that a collaborative process results in better outcomes for all stakeholders. That lesson should not be forgotten, as the industry takes a more prominent role in defining the future of loss-mitigation offerings.”