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July 6th, 2011

Your toxic loan could be a blessing in disguise

by Peter Miller


Underwater homeIf your current mortgage is an option ARM, it’s possible that you may soon get a principal reduction or a lower interest rate…even if you don’t apply for a mortgage modification.

“Two of the nation’s biggest lenders, JPMorgan Chase and Bank of America, are quietly modifying loans for tens of thousands of borrowers who have not asked for help but whom the banks deem to be at special risk,” said the New York Times.

This is an interesting turn of events, given the seemingly widespread notion that the big banks are the bad guys.

Option ARMs are prime candidates

According to the Times, the banks are reducing mortgage balances for borrowers with option ARMs, one of the worst financing products ever foisted on the public. (Note: neither lender originated such loans; they were sold by failed lenders Countrywide and Washington Mutual, companies purchased in 2008 by BofA and Chase, respectively.)

Principal reductions: Investors and (some borrowers) still hate the idea

No less important, the idea of principal reductions is one of the most contentious in mortgage financing. Basically, investors don’t want to write down principal balances because it is bad business, and a lot of borrowers (who don’t qualify) think the idea is unfair.

How does this “program” work?

While there are very few details surrounding this “program,” my suspicion is that the Chase and BofA initiatives work like this:

1.  Borrowers must be located in some of the worst foreclosure areas, places where property values have fallen through the floor and are not likely to soon recover. (The example cited by the Times involves a Miami condo owner who had her $300,000 mortgage cut in half.)

2.  Local home values must be so low that walking away from the mortgage could make some financial sense for the borrower.

3.  There must be no hope of financial salvation for the lender: The foreclosure, short sale or sale of the property will not come close to satisfying the debt.

4.  The loan servicer must gain permission from the investors to reduce the principal or change loan terms.

5.  Each loan is different. Some borrowers may see an interest-rate reduction but not a principal write-off, while others may see a principal reduction plus a new loan type.

Best option: modify before they walk away

In effect, these lenders are conceding that with option ARMs the original loan underwriting was so awful, the loan product was so toxic and the local market is now so woeful that the best decision is to change the loan terms before the owner simply walks away.

However, how these lenders are actually deciding which loans to modify is still a mystery to me. Obviously, you would expect these lenders to examine loans in major foreclosure centers, but I know for a fact that modifications are plainly being made where circumstances are not so dire.

The “wrong” borrowers are still being modified

I know about this because I live in Washington, D.C., one of those rare pockets of real estate where home values are actually rising. Also, my mortgage lender is one of the two mentioned throughout this post.

Even so, one day about six months ago my lender offered to reduce the current mortgage rate on my fixed-rate loan and pay all the closing costs. I instantly agreed.

So why would a lender be so generous? There was no generosity involved. By refinancing our loan the lender created a new mortgage which could then be re-sold in the secondary market at a profit. Everyone wins. Done thousands of times, a savvy lender can generate big profits and keep borrowers with good credit from refinancing elsewhere.

So, it seems that more lenders are focusing in on modifications as a way to not only erase toxic loans from their books, but also as a way to increase profits and keep their best customers from taking their business elsewhere.

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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