Will loan amortization solve the underwater borrower problem?

Many housing market analysts erroneously believe loan amortization will rescue underwater borrowers. Many loan modifications don’t amortize, so those borrowers are not reducing their debts.

When borrowers owe more on their house than it’s worth, they are underwater; that’s a problem because they can’t sell and move when they want. About 20% of Americans are underwater on their mortgage, and another 15% to 20% can’t sell for enough to pay off the mortgage and provide equity for a subsequent purchase. The lack of borrower equity hinders housing because it prevents those who are underwater from listing and selling their homes — hence the low inventory today — and it weakens demand in the move-up market because move-up equity doesn’t exist.distressed_borrowers

There are only two solutions to the underwater borrower problem: either house prices must go up, or debt levels must go down. As we’ve seen locally, house prices hover on low volume because the market is limited by the ceiling of affordability, so lender efforts to reflate the housing bubble back to peak pricing are likely to fall short. As housing markets across the country reach the limit of bubble reflation efforts, the only alternative is for borrowers to pay down their mortgages.

Fortunately, at very low interest rates, more of the payment goes toward principal than at higher rates, and we’ve had near-record low interest rates for several years. Those borrowers are amortizing their loans quickly, and any of them who are underwater will not be underwater for long. This prompts many to erroneously believe amortization on loans will solve the underwater borrower problem in time because whether or not house prices move up, loan balances are going down. Unfortunately, that is not the case.

Many of those most deeply underwater borrowed too much money at the peak either to buy or to refinance. Most couldn’t afford a fully-amortized payment on the loan, so when they borrowed, they either used interest-only or negative amortization loans. Many of those loans blew up and were foreclosed, but many more were modified. Most private-label modified home loans do not amortize. These loans were designed by lenders to benefit lenders, as I documented in Lenders benefit from loan modifications, homeowners not so much.

Loan amortization will not solve the underwater borrower problem because far too many of these loans don’t amortize. The borrower is making no progress on reducing their loan balance. In my opinion, today’s loan modifications are tomorrow’s distressed property sales. Since the OCHN is generally well ahead of the mainstream media in reporting these issues, it should come as no surprise to regular readers that the problem with can-kicking loan modifications is just now coming to light.misfortune_teller

With clock ticking on mortgage relief, homeowners wonder what’s ahead

By Dina ElBoghdady, Published: March 10

Five years after the federal government bailed out more than 1 million struggling homeowners, many who got the relief may end up losing their homes after all.

They were always going to lose their homes. Only wishful thinking was preventing people from seeing this fact.

Already, nearly 30 percent of those who qualified for relief have defaulted again.


And roughly 800,000 borrowers who remain enrolled in the government’s flagship program will see their mortgage interest rates gradually rise starting this year — eventually increasing payments by more than $1,000 a month in some cases, according to a recent federal analysis.

As the higher payments kick in, regulators and consumer advocates fear that homeowners won’t be able to stay current on their mortgages, ….

“The program was a temporary Band-Aid,” said Greg McBride, a senior financial analyst at

In other words, this was admittedly can-kicking by lenders and borrowers hoping for a miracle or a larger bailout that was not forthcoming.

“Five years later, that Band-Aid is going to be ripped off.”

Ripped off? Hardly. Loan modifications increase payments slowly over time. It’s far more accurate to portray this as removing the band-aid slowly. It will still be painful, and very few will survive, but there is nothing sudden about the increase in payments.

The initiative was based on the flawed assumption that the economy would bounce back more quickly, undoing the damage wrought by plunging home prices and high unemployment.

No, the mistake with the program was a failure to properly define the problem. The damage was not caused by plunging home prices and high unemployment. Those were a result of the collapse of the credit bubble — that was the problem. Lenders created far too much debt and overloaded borrowers who reacted by Ponzi borrowing to sustain their lifestyle.

The program lowered the monthly mortgage payments of qualified borrowers for five years, presumably long enough for them to regain their financial footing. …

Apparently, they presumed wrong.


Obama administration officials defend the Home Affordable Modification Program (HAMP). But they say they are prepared to respond if there is a significant uptick in delinquencies among the homeowners.

The outcome could determine how far the administration is willing to go on behalf of homeowners, experts tracking the issue said. …

The question becomes: Will Treasury help them get back on their feet in the same way it helped the banks get back on their feet?” said Christy Romero, the special inspector general for the Troubled Asset Relief Program, which oversees the handling of the bailout money. …

These borrowers have had five years to get back on their feet. How much time do they need? Are we talking about helping people in a temporary circumstance, or are we talking about providing a permanent subsidy to people who never could afford their properties? It makes a difference. Temporary help is easier to support than a permanent subsidy.Loan_Mod_Dance

Most of the borrowers who qualified for HAMP had their interest rates cut for five years, some to levels as low as 2 percent, so that their mortgage payments did not exceed 31 percent of their gross monthly income. After five years, the rates are supposed to rise by up to a full percentage point a year until they reach whatever the average interest rate was for a 30-year fixed-rate mortgage at the time the loan was modified.

After all the increases take effect, the median monthly payment would rise by about $200 a month, according to a recent analysis of Treasury Department data. But many will face steeper increases. In California and Hawaii, which have a high concentration of HAMP modifications, the median increases will be $300 and $356, respectively. In California, payments will jump by as much as $1,724 in some cases.

And the alternative is for taxpayers to keep paying the subsidies to borrowers who can’t afford their homes. Loan modifications succeed by increasing borrower entitlements, and I think that’s bullshit.slow_dancing

Pauline James, a New York City homeowner, is one of those other borrowers.In 2010, James lost her job at a bank and her lender agreed to cut her interest rate to 3.6 percent. She and her husband, a city employee, have barely managed to keep up ever since, she said. In December, they learned that their interest rate would increase to 4.6 percent, which it did this month, adding $200 to their monthly payment. It will keep climbing over the next several years, she said.

“I don’t know how this is going to work, because I still don’t have a job,” said James, who was on unemployment and now receives Social Security. She has been trying to modify her loan again without success. “Things have gotten worse, not better. Why do they think I can pay more money?” …

Nobody thinks she can pay more money. What nobody wants to tell her (but I will) is that she needs to get out of the property she can’t afford. She needs to sell, using a short sale if necessary, or walk away and let the bank foreclose. This borrower is a classic example of someone trying to turn a temporary measure into a permanent subsidy. Personally, as a taxpayer, I don’t want to be subsidizing her lifestyle with my tax dollars. There is no legitimate public purpose here; I don’t benefit from that and neither does anyone else.


“Right now, we’re not seeing a lot of data saying that people whose loans have reset are more likely to default after having been current for five years,” Bowler said. “This is an issue we are monitoring closely, and we are determined to stay ahead of the curve.”

Yes, I fully expect them to continue can-kicking as these people get in trouble. At some point, the debate over temporary help and permanent subsidy must take place. After five years, it’s starting to look a lot like an undeserved permanent subsidy.

The outcome could turn on the strength of the economic recovery and whether the recent gains in home prices can be sustained and even improved, mortgage industry experts said. …

If they don’t kick the can on these loans, we will see many more foreclosures, which would certainly help with our depleted inventory problem.proven_failure

“I think a lot of investors would be very unhappy with extending this program forever,” Piskorski said. “The whole point of HAMP was not just to help borrowers but to help investors preserve money. Investors might prefer foreclosure to getting very low payments for another 10 or 20 years.”

At the end, finally a grain of truth. Washington enables Wall Street to ransack Main Street, and these loan modifications are a clear example.

Loan modifications were intended to kick the can long enough for house prices to rise to the peak where lenders will rescinded the perceived entitlement. This has partially succeeded over the last two years, but house prices are running into resistance at the affordability ceiling, and since the mortgage regulations changed how real estate markets work, it’s not likely lenders will be able to fully reflate the bubble and resolve all their bad loans with equity sales.

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