An Adjustable-Rate Mortgage Modication: Change Terms on Risky Home Loans

Panel members at a Congressional hearing on the subprime crisis recommend changing the terms of ARMs to forestall foreclosures.

A series of speakers at a Congressional hearing of the House Financial Services Committee on Tuesday called for restructuring adjustable rate mortgage loans to help solve the subprime mortgage crisis.

With as many as 2.4 million American homeowners facing potential default on their subprime mortgages during the next couple of years, there’s much interest in Washington providing relief.

Nearly all the parties speaking before the committee agreed that one of the best ways to work out the problems is to move borrowers out of hybrid adjustable rate mortgages - the so-called exploding ARMs - and into fixed-rate loans.

Exploding ARMs feature low initial “teaser” rates that reset after two or three years at much higher levels that can run past 10 percent. The payments on fixed rate mortgages stay the same throughout the lengths of the loans.

Panelists at the hearing included spokesmen for Freddie Mac and Fannie Mae, the Federal Deposit Insurance Corporation, Housing and Urban Development, as well as consumer groups, lenders and real estate investors.

Ohio Congresswoman Marcy Kaptur, whose state leads the nation in foreclosure rates, was the first panelist to speak and recommended a three-pronged approach to bad credit home loan modification:

1. Establish rescue funds for borrowers facing short-term problems caused by illness, layoffs or other one-time events.
2. Establish a bond fund to pay for switching borrowers out of unaffordable ARMs. The Ohio housing market has already started a bond fund to put subprime ARM borrowers into 30-year fixed-rate loans at 6.75 percent interest.
3. Refinance mortgage loans for victims of predatory lending. This would involve working with Fannie Mae, the quasi-governmental corporation.

Such loan modifications would require the cooperation of lenders who would have to be willing to accept lower returns on their investments.

Many lenders may be willing to go along with these plans in order to avoid the cost of foreclosures, which can be considerable.

Doreen Woo Ho, president of Wells Fargo Bank’s Consumer Credit Group, says: “You can pretty much figure an OREO (other real estate owned by the bank, basically, foreclosed properties) will automatically cost 6 percent commission to sell, plus the cost of carrying it on the books for the six months or more it takes to sell and the cost of deferred maintenance. Right away 10 to 15 percent of the value is already eaten by the costs.”

Even when the property sells, the lender gets much less than what it has invested in it. Foreclosures usually sell for about 28 percent below fair market value, according to RealtyTrac, a marketer of foreclosure properties.

By some accounts, the expense of a foreclosure comes to, on average, about $60,000 and takes a year and a half to resolve. For lenders, it’s much more profitable to rewrite the terms of the loan if it enables owners to keep paying it off.

And many borrowers have already demonstrated their credit worthiness by making two or three years of payments during the initial, fixed part of the loan. It’s only when the loan resets at much higher mortgage rates that many of them fail to make payments

SOURCE: CNN Money