In addition to analyzing the factors that have constrained the success of the Home Affordable Modification Program (HAMP) the Solicitor General for the Toxic Asset Relief Program (SIGTARP) also looked at factors that might impede HAMP's success going forward.

As was explained in the first piece of this commetary, SIGTARP evaluated the HAMP program in an effort to find why HAMP has, thus far at least, fallen below expectations for putting distressed homeowners into permanent loan modifications.  The study found, that among other factors, the HAMP program had not clearly articulated the goals for the program nor had it clearly stated the guidelines for the program until after participating servicers had already began program implementation.  It also faulted the program for inadequately marketing the program to its target audience.  The findings were presented to Treasury Secretary in late March.  

SIGTARP also sees five areas where HAMP's future success might be impeded;


The report pointed out that the Treasury Department is estimating that 40 percent of borrowers who receive either trial or permanent loan modifications will default on those modifications and potentially be in danger of losing their homes to foreclosure within the five years that the modifications are slated to be in effect.  The report said it is still too early to evaluate the impact of re-defaults on the program's success or on the accuracy of Treasury's re-default estimates.

Limitations on debt-to-income eligibility ratio:

Unlike most underwriting, the affordability ratio that HAMP has chosen to use replies only on a "front-end" calculation, with no restrictions on debt level beyond that presented by the mortgage itself.  This has the potential of overestimating the true ability of borrowers to make their modified payments in either trial or permanent modifications.  Rather than excluding borrowers with high "back-end" ratios resulting from car payments, credit card debt, and second mortgages, those with total debt ratios exceeding 55 percent must merely sign an agreement to work with a HUD-approved debt counselor.  The report points out that, as of last December, borrowers with debt rations greater than 50 percent represented more than half of HAMP permanent modifications while nearly a third had total ratios exceeding 70 percent.  "This problem is exacerbated by the unacceptably high unemployment rates which will potentially increase household debt and could have a dramatic impact on re-default rates."  

Five Year period of permanent modifications:

Treasury based the five year length for modifications on an analysis used to determine "a reasonable time frame for price recovery including review of future prices, a statistical analysis of the steepness of actual price declines, consideration of broader macroeconomic forecasts, experiences of other modification programs, and judgment." 

HAMP modifications are adjusted to below prevailing market rates which, after the five year period, can incrementally increase by up to one percent per year capped by the 30-year rate prevailing on the day the modification agreement is drafted.  These increases could hinder borrowers' ability to pay if income does not increase commensurate with the interest rate adjustments, mimicking the situation which led to widespread defaults for sub-prime adjustable rate mortgages during the current crisis.  The report uses the HAMP average unpaid principal balance of $247,149 and average remaining term of 327 months to project a monthly payment that will increase 23 percent by the fourth year after the permanent modification if the rate is increased the maximum of 1 percent per year.  Current projections, the report says, suggest that salaries may not increase by a corresponding rate.

Second liens:

Treasury estimates that up to 50 percent of mortgages at risk of delinquency or foreclosure are backed by a junior lien.  Where these liens exist they can hamper a borrower's ability to make payments under a modification unless the second lien is also modified or extinguished.  HAMPs second lien program requires that, if the lender holding a second lien is also a HAMP participant, that lender must agree either to modify the loan under a defined protocol or accept a lump sum from Treasury in exchange for full extinguishment of the lien.  Even though this second lien program was announced in April 2009, it has not been fully implemented and participation has been "extremely limited."  Bank of America, Wells Fargo, and Chase have recently signed on to the program so it is hoped that participation will be improving.

Negative equity and strategic defaults:

Negative equity presents substantial risk to HAMP's effectiveness.  The program's rules do not require servicers to address negative equity, i.e. the borrower owing more than the property is worth, however, the report quotes an industry expert who calls it the "most important predictor of default."  It is estimated that the 25 percent of all borrowers nationwide with negative equity represent almost half of all foreclosures.  SIGTARP said it was not able to obtain documentation to support the different estimates as to the weighted average of the combined mortgage loan amounts compared to the home's value for all borrowers in HAMP trial modifications but the numbers all indicate that the average HAMP mortgage is underwater.

Treasury Secretary Geithner has said that his department made "a conscious choice" not to start HAMP with principal reductions because they were more expensive for taxpayers, harder to justify, and had a higher risk of unfairness.  The report said that in this context, borrowers who are current on their mortgages may consciously choose to stop paying their mortgage if they are aware that delinquent borrowers receive incentives and financial assistance under HAMP.

The practice of a borrower choosing to default even when he can afford the mortgage payments is called strategic default.  This usually occurs in the case of negative equity and thus may become a factor in HAMP re-defaults as borrower decides that it makes more economic sense to walk away from a mortgage and rent at a lower cost than to continue making higher payments that may never result in obtaining equity in the property.

The SIGTARP report contains significant conclusions and suggestions for improvements to HAMP.  We will cover these in a third part of this article.