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The prospect of mortgage-debt forgiveness will entice hundreds of thousands of homeowners into picking up the phone to play the home-preservation game of "Let's Make a Deal."
The federal government's Hope for Homeowners plan started Oct. 1, and a home-retention program for some Countrywide Financial customers will begin by December. Both initiatives promise to help qualified homeowners avoid foreclosure by giving them lower monthly house payments.
Under the mortgage-relief programs, some people will get reduced interest rates, temporarily or permanently. Others will have a portion of their home debt wiped away. Some will get a combination of a reduced rate and loan forgiveness. Still others will wind up disappointed.
But the initiatives will at least spur troubled borrowers into calling their mortgage servicers or credit counselors. In about half of foreclosures, the borrower doesn't talk to the lender.
The Hope for Homeowners program is supposed to help up to 400,000 homeowners who can't afford their mortgage payments and who can't refinance to get a lower rate because they owe more than their houses are worth. Without help, these people will end up in foreclosure. Hope for Homeowners encourages lenders to forgive some of the debt of these troubled homeowners so they can refinance into mortgages insured by the Federal Housing Administration.
The criteria for eligibility:
- A house has to be the borrower's primary residence. It can't be a second home or an investment property.
- The mortgage must have been originated before Jan. 2, 2008. The borrower must have made at least six payments.
- Payments must be unaffordable without help.
- House payments must be more than 31% of before-tax income.
- The borrower must not have lied on the loan application, intentionally defaulted on debts or been convicted of fraud in the past 10 years.
Debt forgiveness is a last optionThe last thing lenders want to do is forgive debt. In September, executives from the four biggest mortgage servicers, in testimony before the House Financial Services Committee, made it clear they would exhaust all loan-workout options before considering debt forgiveness, which in banker lingo is called "principal reduction."
An executive for Bank of America told the committee that his bank would consider debt forgiveness for people who are already in foreclosure. A Wells Fargo executive, Mary Coffin, said, "We have found that the same affordability can be reached through a 2%-to-3% interest-rate reduction and term extension as can be reached through a 25%-to-30% principal reduction."
In other words, Wells Fargo would rather reduce the interest rate for five years, and extend a 30-year loan into a 40-year loan, than forgive some of the debt.
How forgiveness would workIf a lender could be persuaded to participate in Hope for Homeowners, here's how it would work: The lender would forgive all the debt above 90% of a home's appraised value and allow the homeowner to refinance with an FHA-insured mortgage.
For example, let's say someone owes $125,000 on a house that has lost value and is now worth $100,000. The owner can't afford the higher payments because of a rate adjustment. The lender would forgive $35,000 of the debt, allowing the owner to refinance with another lender for $90,000. That loan would be insured by the FHA and have an upfront FHA insurance premium of about $2,700. In most cases, that $2,700 would come out of the hide of the old lender, on top of the $35,000 in debt forgiveness. Faced with these figures, some lenders might figure it might be cheaper to foreclose.