America Has A "Broken ARM" And Band-Aids Are Not The Answer
Lately, it is common to find financial experts debate
whether America is heading into a slow down, near recession
or recession, much the same way that others debate whether
certain physical symptoms are those of the flu or a cold.
While it is helpful to correctly diagnose the physical
malady, the bottom line is that regardless of the problem,
the patient feels bad and needs a cure or, at the very
least, some form of medication that will help him recover.
Much like these ailing patients, many homeowners holding
various types of adjustable rate mortgages (ARMs) are
facing their own problematic symptoms including job losses,
declining home values, rising interest rates, and the
possibilities of default and foreclosure. Regardless of
their different symptoms, unless they have sufficient
income and their homes' values exceed the outstanding
principal balances on their mortgages, they cannot continue
to pay off their ARMs once their loans adjust to a higher
rate. These loans are what I refer to as "Broken ARMs," and
we need to fix them FAST.
One type of Broken ARM is the subprime ARM, which typically
starts with a fixed rate of interest for two or three years
and then adjusts thereafter every six months or so.
Borrowers holding these mortgages saw a first adjustment
that raised their rates up to 3% over their initial rate,
and additional adjustments thereafter.
Another type of Broken ARM, the "pay option ARM," allowed
borrowers to pay interest rates lower than the rates
required under the terms of the promissory notes securing
their mortgages, while the mortgage balances swelled to
absorb the difference between the note rates and the pay
rates. In many cases, these borrowers' loans increased to
115% of the original principal balance. To make matters
worse, the:
- Original principal balances on both subprime and pay
option ARMs were equal to or approaching 100% of the
appraised values of the homes at the time the loans were
made.
- Creditworthiness of these borrowers (their likelihood of
paying back the loans) was such that they could have
qualified for conventional loan products (as opposed to
subprime or pay option ARMs) at the time the loans were
made.
- Creditworthiness of the borrowers (their financial
ability to pay back the loans) was accepted "as stated"
rather than verified using traditional underwriting
practices.
- And home values have since fallen 20% or more in many
areas of the country.
This situation, often dubbed the subprime crisis, will
continue for three or four years as various Broken ARMs
come of age, and the loans will likely end up either in
foreclosures, short sales or bankruptcies. That is, unless
a solution is found that will completely address the issues
once and for all without regard to default status of the
borrower, capabilities of the servicer, and uncertainty as
to its applicability. The plan must be for all homeowners
who financed after 2003 into any one of the Broken ARM
products and it may need to be extended to address some
unsettling news in the conventional arena. Absolutely
essential to the success of any program is to realize that
we have until the end of 2008 to address the relatively
large loans endemic in California, Florida, New York and
other locales thanks to the increased loan limits in the
Economic Stimulus Act recently passed. To date, we have
tried FHA Secure, Hope Now Alliance, Project Lifeline and a
few small scale programs. Read the papers, talk to industry
experts, ask your neighbors. All nice tries, but they
aren't doing the job. Nor will they ever.
Moreover, it's my feeling that any government sponsored
plan will likely miss the point. While there are many
bright, well-meaning politicians working to come up with
something, they really don't understand the mortgage
industry. It's really up to us, the men and women in the
mortgage banking industry to come up the answer. We
certainly had no problem working in concert with Wall
Street and the borrowers over the last few years in framing
this issue. The time has come to solve it. Others better
equipped than I will work on assessing blame and
controlling future mortgage trends. The job of this article
is to propose a solution that can be embraced by all.
I call this solution "Appreciating America." It's a plan
that should be adopted by all of the servicers, promoted to
all of the ailing homeowners and supported by the US
Government, especially the Federal Housing Administration
(FHA). FHA has told me that the use of this solution would
fit exactly within the current FHA guidelines. It's a
fairly simple plan, which can be put into effect
immediately since it utilizes time-tested mortgage programs
used in the commercial arena, which are generally referred
to as shared appreciation mortgages. I believe that this is
what Chairman of the Federal Reserve, Ben Bernanke, was
suggesting yesterday when he stated: "The fact that many
troubled borrowers have little or no equity suggests that
greater use of principal writedowns or short payoffs,
perhaps with shared appreciation features, would be in the
best interest of both the borrowers and lenders."(Italics
added). I couldn't agree more.
Appreciating America works as follows:
- The homeowner refinances outstanding mortgages with an
approved "Appreciating America Lender" in accordance with
established FHA guidelines regarding loan-to-value (LTV)
and debt-to-income ratios (DTI). The loan is fully
supported by sufficient income, LTV limitations and tied to
past mortgage payment history.
- The Appreciating America second mortgage is held by the
current mortgage servicer and defers payments and interest.
The homeowner and lender will share in the future
appreciation of the home to pay off the Appreciating
America second mortgage within five years.
- The new Appreciating America second mortgage is a
subordinated second shared appreciation mortgage equal to
the difference between the new FHA mortgage and the
existing mortgage(s). This second shared appreciation
mortgage will accrue interest at 6%, with payments
deferred, and will not be payable until five years after
the loan is made (or the home is sold). At that time, the
homeowner has a choice of refinancing the mortgage(s) or
selling the home.
- To the extent that the value of the home at that point is
greater than the FHA first mortgage amount, the homeowner
will first receive an amount equal to all capital
improvements made to the property since the Appreciating
America mortgage closed, and then the homeowner will
receive 30% of the appreciation and the second mortgage
holder will receive the lesser of 70% of the appreciation
or the principal and accrued interest on the Appreciating
America second mortgage. All appreciation in excess of the
second mortgage balance including accrued interest shall
belong to the homeowner.
The benefits of the Appreciating America plan are
significant. Families will remain in their homes. With the
promise of shared appreciation and protection of capital
expenditures, the homeowner will be motivated to maintain
and improve the property. The existing lender will not have
to incur large losses in foreclosing or agreeing to a short
sale in a dropping market. In fact, the servicer will
receive the entire available proceeds from the new FHA
mortgage as repayment on their original loan and may
realize the remaining balance through future appreciation.
Property values throughout the US should stabilize.
Together, these benefits should have a positive impact on
the US economy while protecting it from further property
value erosion.
An example of this transaction is as follows:
- Original mortgage(s) = $200,000
- Current property value = $180,000
- Homeowner qualifies for a new $153,000 FHA first mortgage
(up to 85% LTV, to include closing costs and FHA insurance
premiums) with existing servicer taking a $47,000 (plus
amount of closing costs and FHA insurance premium) shared
appreciation Appreciating America second mortgage.
- Current mortgage holder(s) get immediate return of
$153,000.
- The balance of $25,400 that the servicer is owed becomes
a shared appreciation Appreciating America loan, secured by
the property but with no payments due. Interest would
accrue at a reasonable rate (6%).
- Property appreciates 3% per year over the next five years
and is appraised at $209,000. Homeowner will qualify for a
new FHA mortgage of approx. $203,000. The appreciation of
$56,000 would be split with the homeowner getting $16,800
and the second mortgage holder receiving $39,200. The
remaining principal balance owed on the second mortgage
plus any accrued interest would be forgiven at that time.
The time is growing short and we need to act fast. The
Office of Thrift Supervision suggested a variation of this,
but included a new, untested feature that will absorb
precious time in rolling out. Appreciating America works
and works well. Debate is a great thing but not when it
comes at the expense of millions of homeowners. The Broken
ARMs need more than a band-aid. Appreciating America is the
remedy that can work.
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Nicholas Bratsafolis is Chairman and CEO of Refinance.com.
In business for nearly 20 years, Refinance.com is one of
the country's largest home mortgage lenders. More
information about Refinance.com can be found at
http://www.refinance.com .
