THE BASIS POINT

Loan Modifications Mean Rate & Balance Changes To Make DTI 38%

When homeowners are approved for a loan, it’s always been the target to get total housing plus other debt obligations to equal 38% or less of income—this is considered the ideal affordability range for any borrower. The problem is that with guidelines of recent years, the income component of the debt-to-income ratio calculation was “stated” which is industry jargon for “made up”. So you could get to a 38% ratio but it was made up.

With FHFA’s joint announcement with Treasury today, it looks like the Fannie/Freddie loan modification program is targeting this amount, even if it means drastic rate or principal balance reductions for borrowers. This is significant progress toward recognizing the extent of the housing problem, but implementation on this is going to be tricky because most leveraged borrowers have second mortgages behind their first mortgages, and when these second mortgages are held by different lenders than the first mortgages it makes it very complicated to do appropriate loan modifications. For now, here’s some details from a WSJ story:

The streamlined effort will target certain loans that are 90 days or more past due. The program will aim to bring the ratio of mortgage payments for these homeowners to 38% of their income by modifying interest rates and in some cases forgiving portions of principal debt.

Borrowers would have to provide a statement or affidavit showing that they have encountered some sort of hardship that has impacted their ability to pay their mortgage. It would only apply to loans made on or before Jan. 1, 2008, and borrowers will be disqualified if they file for bankruptcy. The homes must be owner-occupied and escrows for real estate taxes and insurance must already be set up.

U.S. government officials plan to encourage big banks that hold loans in their portfolios to take similar streamlined modification measures.

Servicers are expected to be paid $800 for a successful modification and loan investors are expected to reimburse servicers for certain fees associated with the modification. There will be a 90-day trial period, and if borrowers successfully make payments for those 90 days the modification will be formally approved.

The program is expected to be an extension of the Hope Now alliance announced last year that aimed to help people avert foreclosure by reworking the terms of their mortgages. Several large banks, including Bank of America Corp., Citigroup Inc., and J.P. Morgan Chase & Co., have announced their own foreclosure prevention plans. Some bankers have complained that Fannie Mae and Freddie Mac weren’t being flexible enough in discussions over loan modifications.

The administration is still discussing a range of other, more extensive options to help homeowners.