WE’RE HEARING from the Empire State, a k a New York, where the governor and the Department of Financial Services have issued proposed regulations to assist homeowners who are underwater. They are not speaking of all the people damaged by Hurricane Sandy but rather those folks who owe more on their mortgage than their home is worth.
The proposal seems simple and a good idea. In exchange for a lender modifying an underwater mortgage with a principal reduction the lender will get a share of the future increase in value of the home.
The devil of course is in the nine pages of proposed regulations. The program would be voluntary for lenders, but lenders would be allowed and “encouraged” (my emphasis) to participate. The loan modifications would be limited to owner-occupied residential mortgage loans (either a first or second or both) on one-to-four family units. The borrower must be at least 90 days behind on payments or in foreclosure and not be eligible for a HAMP mod, an FHA mod, or a traditional refi or HARP.
The new interest rate on the modified loan cannot be higher than the original pre-modified mortgage loan and the lender must maintain documentation supporting the new interest rate including rate sheets and pricing charts detailing any margin applied. There are very specific disclosure requirements and the borrower must complete counselling which explained the terms of the transaction to them or be represented by an attorney.
For a mortgage modification which conditionally reduces the amount of a borrower’s principal loan balance the lender will be able to share in the future appreciation of the property according to a formula. First, the appreciation in value is calculated by subtracting from the gross sales price of an arm’s-length sale the amount of the real estate brokers commission and the appraised value of the property when the modification agreement is entered into. No other seller closing costs are deducted. Next, there is a cap on how much of the appreciation the lender may keep.
The lender may keep the lesser of the amount of the reduced principal loan balance plus interest on that amount based on the new interest rate or 50% of the amount of the appreciation in value as described above. A lender who agrees to this arrangement is protected if the borrower refinances or the property is sold within one year of the completion of the loan mod. In this case the entire principal balance has to be repaid plus interest.
The lender benefits in this scenario because they will not lose money on a short sale or resale of the property taken back in foreclosure. The homeowner gets a lower monthly payment for a period of time which should enable them to make payments. Foreclosures will be reduced so that neighborhoods will not deteriorate and market values will have a time to stabilize and ultimately increase.
There are some other restrictions which may not make lenders too happy. Some prohibitions include that a lender may not require a borrower to waive any claims it may have against the lender, there can be no fees charged specifically for doing the mod, and the modified loan may not contain a prepayment penalty. Hopefully these limits will not discourage lender participation.
Based in Chelsea, Mich., John McDermott is a real estate and elder care attorney who represents both consumers and businesses. He can be emailed at email@example.com.