Who will get relief from subprime mortgage mess

3 min read

Advice for homeowners who are still paying the teaser rates on their subprime mortgages: Keep making those loan payments, and answer the phone when the lender calls.

Homeowners who follow those two rules might be able to take advantage of a plan to prevent mass foreclosures. The initiative, released Dec. 6, was dreamed up by bankers and federal regulators. With a bean-counter’s tin ear for English, they call it the “Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans.” It’s as complicated as the name implies.

But for now, the advice is simple:

“What’s most important under this protocol is to stay current on your loan,” Sheila Bair, chairman of the Federal Deposit Insurance Corp., said during the White House’s dog-and-pony show to announce the plan. And, she added, get on the phone to your loan servicer.

Help is coming in three ways
Subprime adjustable-rate mortgages are known as 2/28 and 3/27 ARMs. They have teaser rates for the first two or three years. After that, the rates jump, and monthly payments can rise hundreds of dollars. Subprime borrowers have flawed credit, and many of them can’t handle such a large jump in monthly payments.

Almost 2 million subprime borrowers face rate reset in 2008 and 2009. Bankers and regulators worry that a wave of foreclosures will ensue. Over the summer, Bair came up with an idea to prevent foreclosures by freezing the introductory rates on subprime ARMs. Her insight was that a lot of people could afford to keep making the payments under the introductory rate but wouldn’t be able to afford the payments after rates reset.

Why not extend introductory rates for those borrowers? Bair’s proposal was dismissed at first as unworkable.

A few weeks ago, Treasury Secretary Henry Paulson adopted the core of Bair’s idea. Industry participants suddenly seemed to take the notion seriously. Paulson gathered lenders, mortgage servicers and investors under the umbrella of a group called the Hope Now Alliance and brokered the deal that was announced Dec. 6.

Under the Paulson plan, mortgage servicers have a set of guidelines that they can use to classify subprime customers into four categories.

4 categories of ‘subprimers’
Hopeless cases who can’t afford their payments under the teaser rates.
Those who can afford their mortgages even after the rates reset and the monthly payments jump.
Homeowners who can refinance into another loan, possibly one insured by the Federal Housing Administration.
People who can afford the teaser rate, but can’t afford a higher rate, and who can’t refinance because they owe more than the house is worth.

Most of the attention to the Paulson plan focuses on that final group. Those homeowners will be offered a deal: Keep making the monthly house payments, and the teaser rate will be extended for five years. No need to worry about the monthly payment jumping by hundreds of dollars. Well, not for five years.

FHA refinance plan
Less attention has been paid to that third group — homeowners who can refinance. It’s really the core group. Servicers will be expected to push these borrowers hard to refinance, preferably into a fixed-rate mortgage. This is where the federal government comes in.

In September, the Federal Housing Administration, or FHA, announced a loan program called FHASecure, for homeowners with marginal credit who have been late on a few house payments recently. Under FHASecure, some of these homeowners are eligible to refinance into FHA-insured, fixed-rate mortgages. Housing Secretary Alphonso Jackson says 35,000 people have refinanced under the FHASecure program since early September, and another 15,000 will do so by the end of this month.

Officials say about 1.8 million homeowners have subprime ARMs that will reset in 2008 and 2009. Of those, about 1.2 million will either be able to refinance or will be offered an extension of the teaser rate. No one offered an estimate of how those 1.2 million will be split up into each of those categories.

Qualifying for the rate freeze
The rate freezes will be offered to people whose subprime ARMs hit their first reset sometime between Jan. 1, 2008 and July 31, 2010. Most of these borrowers have loans with interest rates between 7 percent and 10 percent. That’s substantially higher than current mortgage rates for people with good credit. This week, the benchmark 30-year fixed in Bankrate.com’s weekly survey was at exactly 6 percent.

To be eligible for a five-year extension of the teaser rate, a borrower will have to be current on the monthly house payments, and not to have fallen behind by more than 60 days within the last year. In addition, the amount owed on the primary mortgage must be more than 97 percent of the home’s value. Because home values have fallen, a lot of people will meet that criterion.

The Paulson plan encourages mortgage servicers to contact borrowers at least four months before the initial rate reset to warn about the higher payments and to discuss the options available. Servicers say that only half of borrowers respond to these overtures.

“It will create an easier process for the consumer once they contact their servicer,” says Mike Hyde, an executive with Wells Fargo and vice chairman of the Housing Policy Council, which took part in the negotiations that yielded the Paulson plan.

Pick up the phone if it rings.