Some state governments have implemented programs to rescue mortgage borrowers in danger of losing their homes. Eight states have committed a total of $900 million to these plans, but a Boston Globe article reports that the uptake has been very low, with only 100 families getting refinancings. If you assume an average mortgage of $300,000, that represents only 3% of the allotted amount. The experience of the states does not bode well for other refinancing initiatives.
What happened? Borrowers are believed to be desperate for any remedy other than foreclosure. Yet Massachusetts, which has the largest program ($250 million) has not refinanced a single mortgages. It isn’t alone in failing to make headway:
In Maryland, the first state to create a refinancing program, officials have found it so ineffective that they are considering shutting it down. The program has made just nine loans in about a year….. Ohio initially expected to serve one of every three applicants; officials say they have so far helped one in 15.
The intent of most of these is to catch borrowers who are likely to default when their loans reset. This construct has two main flaws. First, comparatively few borrowers fit the profile that the various states wrote into their initiatives. Second, lenders are often unwilling to write the mortgage down if the mortgage balance is higher than the market value of the house.
On the first failing, the Globe explains the mismatch between the screening criteria and the universe of borrowers in trouble:
The vast majority of the applicants aren’t eligible for refinancing. They have either fallen too far behind on their payments, have badly damaged credit, or simply owe more on their loans than the value of their homes, making refinancing effectively impossible….the programs primarily were designed to help only a portion of the population with problem mortgages: those who can make their payments now, but are facing unaffordable rate increases….
The stalled state efforts highlight the general difficulty of helping homeowners avoid foreclosure: Officials have only a short time frame to act before borrowers fall too far behind to be helped. Yet the circumstances of each loan are unique and complex – “Like snowflakes,” said one official – making it is impossible to process cases routinely.
The second obstacle is that lenders are often unwilling to take the losses required by the states:
The state programs, which work in similar fashion, do not lend money directly to homeowners and are not funded with tax dollars. Instead, qualified applicants are referred to traditional lenders, who can resell the mortgages they make to state housing finance agencies. Because the agencies are assuming the lenders’ risk, borrowers are able to qualify for lower rates and payments than they otherwise would receive…. lenders often must be persuaded to accept a financial loss to make the refinancing possible….success will depend on the state’s ability to persuade lenders to swallow losses in connection with the refinancings, officials say. Declining property values have left many borrowers with mortgage balances greater than the current value of their homes. Those loans must be replaced with loans that do not exceed the homes’ values.
The Patrick administration has said it would urge the holders of the mortgages to accept partial repayments. For example, a borrower who owed $350,000 and lived in a house that is now worth $300,000 would receive a new $300,000 loan through the state program. The original mortgage company would agree to accept a repayment of $300,000 and swallow a $50,000 loss.
While Massachusetts still claims that its housing agency is finding that servicers are becoming more responsive, Elizabeth Warren at Credit Slips argues that lenders are unwilling to give up their leverage over borrowers:
Because foreclosures in Massachusetts have tripled in the last year, the governor set up a $250 million rescue fund…. There are many reasons for the failure, but a critical problem is the hostage value of the house.
A side note for the Not-Commercial-Law-Jocks: “Hostage value” in secured lending refers to the ability of a secured lender to extract a payment in excess of the value of the collateral from a borrower by threatening to repossess the collateral. The classic example was the old practice of taking a security interest in all of a family’s household goods, which might add up to a resale value of $2000, then demanding that every penny (plus interest) of a $10,000 loan be repaid before the security interest would be released. This version of the practice involving household goods is now banned by the FTC. In bankruptcy law, undersecured claims would be bifurcated into its secured ($2000) and unsecured ($8000) portions (see Bob Lawless’s recent post).
Rescue programs limit their payouts to 100% of the value of the property, which makes sense both to protect the fund and not to reward the mortgage lenders by paying them more than they could get for the house if the family gave it back to the lender. But the mortgage lenders want more. If they don’t get it, they won’t release the mortgage–even though the lenders won’t get anything close to 100% of the value of the home if they are forced to foreclose. They hold the home hostage: Pay the amount the mortgage company wants or move out of the house. Some families will find the money to pay, and others will lose their home.
The mortgage lenders are counting on the leverage of their hostage taking to do better than 100% payment. So long as they hang on. rescue efforts are irrelevant and renegotiation won’t work.
The bankruptcy amendments that passed the House this week would break the hostage value of the home. The amendment would give families a chance to negotiate deals that would take them out of ruinous mortgages and let them get into something that is affordable–with or without a rescue plan. The mortgage industry opposes the bill, saying it will decide “voluntarily” when they will or will not turn a homeowner loose–which is another way of saying they want to hang on to the hostage value.
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Hostage value is a pristine example of relying on historic models – in this case, historic assumptions – which may or may not prove to have currency.
A troubled borrower with little or no skin in the game beyond payments to date is, in fact, no hostage at all.