The Obama administration's plan has three main elements: an effort to help homeowners refinance, another effort to help stabilize the housing market through a $75 billion initiative aimed at reaching up to four million at-risk homeowners, and a third element that aims to drive down mortgage rates. The total cost of the initiative could reach $275 billion because of new commitments to Fannie Mae and Freddie Mac.
Fannie Mae and Freddie Mac, privately held companies currently under government receivorship, figure prominently in the housing plan.
Under current laws, Fannie and Freddie are prohibited from owning or guaranteeing mortgages that are more than 80% of a home's value, as those loans are seen as much riskier. But the Obama plan would allow them to buy or guarantee these riskier loans if they already own or guarantee them. This could be possible if a $80,000 loan was purchased by Fannie Mae last year for a $100,000 house, but the house is now worth just $75,000.
The government said it would increase its limits on the size of Fannie Mae and Freddie Mac's portfolios to $900 billion each up from $850 billion and that the Treasury will increase its preferred stock purchase agreements with the companies to $200 billion each from $100 billion each.
The White House also called for a controversial provision to allow bankruptcy judges to rework the terms of mortgages in court. The banking industry has fought bitterly against such a law for years, though some banks have recently softened their stance. Banks argue that by not allowing judges to restructer mortgages in a bankruptcy proceeding, the costs of borrowing can be kept down.
The plan includes multiple incentives to prod servicers to modify loans. Servicers can receive an up-front payment of $1,000 for each eligible loan modification that meets certain criteria. The government said it would pay servicers $500 and mortgage investors $1,500 if at-risk loans are modified before borrowers fall behind. The government said it would also help pay down the principal of certain mortgages by up to $1,000 a year for up to five years if the borrower doesn't miss any payments.
For a loan to qualify for modifications, lenders would need to bring the monthly mortgage payment down to 38% of a borrower's monthly income. The government would match further reductions in the interest rate down to 31%.
A Shared Effort to Reduce Monthly Payments: For a sample household with payments adding up to 43 percent of his monthly income, the lender would first be responsible for bringing down interest rates so that the borrower’s monthly mortgage payment is no more than 38 percent of his or her income. Next, the initiative would match further reductions in interest payments dollar-for-dollar with the lender to bring that ratio down to 31 percent. If that borrower had a $220,000 mortgage, that could mean a reduction in monthly payments by over $400. That lower interest rate must be kept in place for five years, after which it could gradually be stepped up to the conforming loan rate in place at the time of the modification. Lenders will also be able to bring down monthly payments by reducing the principal owed on the mortgage, with Treasury sharing in the costs.
“Pay for Success” Incentives to Servicers: Servicers will receive an up-front fee of $1,000 for each eligible modification meeting guidelines established under this initiative. They will also receive “pay for success” fees – awarded monthly as long as the borrower stays current on the loan – of up to $1,000 each year for three years.
Incentives to Help Borrowers Stay Current: To provide an extra incentive for borrowers to keep paying on time, the initiative will provide a monthly balance reduction payment that goes straight towards reducing the principal balance of the mortgage loan. As long as a borrower stays current on his or her loan, he or she can get up to $1,000 each year for five years.
Reaching Borrowers Early: To keep lenders focused on reaching borrowers who are trying their best to stay current on their mortgages, an incentive payment of $500 will be paid to servicers, and an incentive payment of $1,500 will be paid to mortgage holders, if they modify at-risk loans before the borrower falls behind.
Home Price Decline Reserve Payments: To encourage lenders to modify more mortgages and enable more families to keep their homes, the Administration — together with the FDIC — has developed an innovative partial guarantee initiative. The insurance fund – to be created by the Treasury Department at a size of up to $10 billion – will be designed to discourage lenders from opting to foreclose on mortgages that could be viable now out of fear that home prices will fall even further later on. Holders of mortgages modified under the program would be provided with an additional insurance payment on each modified loan, linked to declines in the home price index.