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Confused About the Rescue Plan? Think Rock-Scissors-Paper

With foreclosures still spiking, it's too early to tell if the Obama Administration's Home Affordable Modification program is going to help millions of borrowers stay in their homes for the long term. But one thing is clear many people in the mortgage industry are confused about the president's housing rescue plan and how it is structured. One even compared it to the children's game of rock-scissors-paper. And confusion over implementation of the plan has caused a temporary halt to foreclosures in the state of South Carolina.

Servicers are complaining the administration is restructuring its housing rescue plan so that servicers are required to compare modifications to short sales as well as foreclosures. Short sales have always been a part of the loss mitigation tools that servicers use, but for some reason Treasury never included them in the original plan. Larry Platt Larry Platt, a partner with the Washington Law firm K&L Gates, says the move is like the game of "scissors cuts paper."

"If modification beats foreclosure, modification wins. If foreclosure beats modification, foreclosure wins. One's rock, one's paper. Now they are adding scissors. If a short sale beats foreclosure, then pursue a short sale. Borrowers are given 90 days to try and sell the property. If that doesn't work, then you start foreclosure," said Mr. Platt.

Given all the delays on foreclosure, it's now going to elongate the period even more, he says. "If a short sale doesn't work, you just added that timeframe to the time you've already lost. This is a disguised moratorium on foreclosure."

The confusion is currently manifesting itself also in a state case where a temporary restraining order has been applied to foreclosures in South Carolina. The trouble is the Obama plan gives specifics as to what loans are in and out of the program, but there is a lot of ambiguity there, too, says William M. LeRoy, president and chief executive officer, American Legal Financial Network, St. Louis.

If folks go into foreclosure without taking advantage of some of the provisions under Obama's plan, then they lose certain rights to modification. That was the fundamental kicker, which prompted a judge in South Carolina to issue a TRO involving loans subject to modifications under the plan.

In a nutshell, Mr. LeRoy says this has temporarily shut down foreclosure sales in the state. "In order for any foreclosures to happen, the lender, investor or plaintiff will have to execute an affidavit indicating that the loan does not qualify for any government programs or that it did qualify but the lender has exhausted all loss mitigation efforts pursuant to the requirements of the programs."

The TRO, which contained a May 15 deadline for affidavits by loan servicers, applies to all loans owned or guaranteed by Fannie Mae or Freddie Mac, or any servicer participating in the Home Affordable Modification program.

"It has been said that the court didn't understand who would be in or out of the program. Everybody is scrambling right now to determine parts and pieces in their portfolios, what specific loans would be parcel to that program," he said.

Who proves whether the loan can or cannot be modified? Who makes that determination?

"At this point it's anybody's guess," Mr. LeRoy exclaims. "Everybody is trying, lawyers on the creditor's side are in contact with all of their clients making sure these affidavits are prepared. On the borrower's side, they are trying to figure out how to respond. A lot of borrowers themselves probably don't even know their property qualifies. It will be interesting to see what happens."

Mr. LeRoy would like the opportunity to sit down with members of Congress along with others from the AFN industry segment, which includes the creditors' lawyers. "There are many parts and pieces to the industry. There has been nothing but individual groups that have handled each of their parts. Now everyone is being forced together probably for the first time in history," he said.

Most firms are doing loan modifications the way the government has intended by reducing the interest rate, extending the loan term, then deferring the principal. Many servicers do each of these three options one after another as they are needed. Jeff Freud Jeff Freud, president of Irvine, Calif.-based LoanMarket.net, believes everything the government is doing is only a temporary fix until price stabilization occurs. "They are taking little baby steps and hoping the market will turn in the next three to six months. If it doesn't, they are creating a never-ending flow of work. Everybody is hoping there has to be a bottom," says Mr. Freud, whose company provides an online marketplace for buying and selling real estate-secured note investments.

"Instead of the Band-Aid where you pull it off quickly but it hurts and its done with and we can start getting in recovery the TARP plan and everything else Obama has done is just delaying and holding out false hope not just for servicers or the investors, but for the homeowners. It's sad, especially for the borrowers who are being told something. If they can get a hold of their servicer or whatever program they get redirected to, it doesn't materialize."

As part of a broader plan to prevent foreclosures and reduce related losses, Wells Fargo has offered principal balance reductions to select Wachovia borrowers. And while many experts agree that mortgage modifications work best when principal is reduced, Mr. Freud says as soon as values go down, the borrowers are going to want the same reduction again. And if a few years from now they are upside down in their property, there is a good chance they will simply walk away.

The second wave of borrowers, the ones who are working hard to stay in their homes, are the ones who can be helped by reduction on interest rates and if servicers give them 12 months or two years of a reduced interest rate payment.

"These are the people who have been in the house before 2005 or 2006. They refinanced or took cash out, they always intended on staying in their house. They've struggled in this economy but they've been on time and made their house payment. Now companies aren't paying overtime. Unemployment is rising. That will be the painful wave. No one is really separating the classifications between this and the first wave," adds Mr. Freud.

"The only way they will stay is if that modification is such that it's lower than market rent in the same area. If they are not leaving the ZIP code, servicers should make the payment on the home equal to or lesser to market rent."