At what point is moral hazard trumped by corporate survival and the cold hard need to get people to pay their mortgages? The answer is: Now.
As home values continue to fall and more borrowers fall into a negative equity position on their home loans, those who stand to lose, banks and investors, are working to keep borrowers current.
To date, they have focused on delinquent borrowers, offering loan modifications and foreclosure alternatives, like short sales and deeds in lieu of foreclosure.
I would tend to agree on the timing aspect. We have very little room in time or potentially further price declines before this ugly real estate market turns toxic, and not just in FL, AZ, NV, and CA.
Last fall, New Jersey-based Loan Value Group launched a new business model, offering lenders and mortgage investors a way to keep their current, but underwater, borrowers current through cash incentives.
It's called Responsible Homeowner Reward, and today, one of the nation's largest mortgage insurers, PMI Mortgage Insurance, joined in.
Here's how it works. Borrowers pay nothing. They sign up with the program, promising to keep current on their mortgages for a certain period, generally 36 to 60 months (LVG has worked out the contract with the participating lender/investor).
After that period, the borrower will be paid anywhere from 10 to 30 percent of the loan principal, depending on the contract, in cash. The lenders/investors pay LVG, which receives a servicing fee, and LVG pays the borrowers. Again, the borrowers pay nothing for this bonus.
Okay, it doesn't matter how you carve it up, eat your loss now via foreclosure and short sale, or eat your loss in the further with a plan like this. In either case, we are identifying investors or lenders have more losses to take and it's really a matter of when they take that loss.
As a side note, if the plan does not pay down the mortgage directly and merely pays out a cash benefit, what's to stop someone from taking the cash and then strategically defaulting in 3-5 years. There's just not enough loan amortization in 3-5 years to make up for the most severely upside down home owners. I hope the plan pays down the mortgage, otherwise the loss could be the cash payment plus default in 3-5 years.
The PMI [PMI 1.34 -0.17 (-11.26%) ] deal works the same, with PMI paying a scaled reward for select borrowers over a five-year period. If the borrowers stay current, they earn the payoff over the five years and receive the cash at the end. PMI created its own subsidiary, Homeowner Reward, but that subsidiary will work with LVG, and PMI will pay LVG an administration fee.
To date, 38 states have borrowers enrolled in the LVG program, totaling approximately 10,000, according to LVG. The largest number of borrowers are from the hardest hit states, California, Florida, Arizona, Nevada and Michigan.
So far, RH Rewards has offered, but not paid out, $107,393,922, according to the company's website.
"All of those states have achieved greater than 50 percent reduction in default rates than respective control group," said an LVG spokesperson.
The delinquency rate may have dropped, however, there is still a payoff and a loss coming if these homeowners fulfill the contractual agreement in 3-5 years. We are simply deferring a loss or write down. I'm not suggesting that's bad, but let's not ignore it completely.
Okay, so now that we get it, we have to ask what exactly are we getting here? From a purely business perspective, it makes sense. By targeting borrowers with the most negative equity and therefore at the greatest risk of strategic default, lenders and investors are cutting their losses by keeping the borrowers current. They stand to lose more in a foreclosure.
But does it sound slightly ironic to anyone else that a mortgage insurance company, whose business is to insure loans by charging borrowers premium fees, is now paying those very same borrowers back to stay current on the loans they're insuring??
"For borrowers in our pilot program, Responsible Homeowner Reward (SM) provides an incentive to stay current on their mortgage by helping them earn an offset to the decline in home values. Such programs, if successful, could reduce the incidence of foreclosure, which could help stabilize house prices and stabilize communities," said Chris Hovey, PMI's SVP of Servicing Operations and Loss Management.
Like I said, it's business, a numbers game where companies have now figured out how much they need to pay to avert a larger loss. Apparently we have hit that tipping point where strategic default is now so pervasive and so acceptable that companies are forced to pay borrowers to stop.
Did he say tipping point where strategic default is now so pervasive and so acceptable? That sounds like Critical Mass to me. Maybe the industry is trying desperately to prevent that from happening!
Lenders are essentially trying to self insure smaller losses than foreclosure while spreading them over time. The potential upside is stability to the real estate market, which benefits lenders. If you can get a large enough segment of the upside down crowd to remain current, that could take some of the pressure off the real estate market as the pipeline for financial distressed real estate subsides.
So what exactly is the difference between that and principal write-down, which the big lenders seem to abhor as a bigger moral hazard even for borrowers facing foreclosure?
In an interview with HousingWire back in April of this year, the managing partner of LVG, Frank Palotta, said, "There is little focus on loss-mitigation efforts for current loans, as these homeowners typically pay. As a result, the vast majority of these homeowners are left with no other option than to become 'the squeaky wheel' by becoming delinquent in order to receive a call from their servicer."
I'm sorry, but a) why do we need loss-mitigation on current loans? These loans are current, and until they go 30 days delinquent, we need to focus our loss-mitigation on the huge volume of borrowers who are in trouble. And b) why do current borrowers have "no other option that to become....delinquent" to receive a call from a servicer? Why does a servicer need to be holding the borrower's hand at every step, cajoling and coddling him/her into fulfilling a contractual obligation?
You need loss mitigation on a current loan because if it's upside down, the further the upside down it is the bigger your potential loss. There's a very good chance you're going to lose money on that loan. I think the industry has enough statistical data to back this thought process up, and has derived at an underwriting model for their plan.
I can say from my experience at managing loans that those who actively manage their loans, and understand potential losses, generally do a better job at minimizing losses than those with the blind eye. Just because a loan is current does not mean it's not a potential loss.
I get a bill every month for my mortgage, and I pay it. Same with the gas bill, the electric, the cable... I realize the mortgage bill is the biggest, and yes, I get that the housing market is still in big trouble and troubled borrowers need modifications and foreclosure alternatives. No argument there.
But current borrowers are current—plain and simple. Why do they need a bonus for fulfilling their financial obligations?? Credit card companies charge you a heaping fee the minute you're a minute overdue, but now mortgage lenders and even mortgage insurers are so afraid of their customers, or have so little faith in them, that they're paying them to pay up? They are literally willing to pay insurance on previously signed legal contracts?
It's not a bonus, it's loss mitigation, which has a benefit for the homeowner. Think of it this way: there is a great deal of motivation to do a strategic walk away even if you are current. It's just a business decision. Now lenders have statistical data that supports the theory they can defer and reduce the losses with a plan like this. Because strategic default is so acceptable and wide spread, an industry plan like this might benefit both the industry and some homeowners. It might be the lesser of two evils.
If a borrower is current and can remain current for five years with a bonus after five years, then that same borrower can stay current without a bonus. That's a financial fact; the rest is, dare I say, enabling bad behavior.
Ah, but they "DO NOT HAVE TO" stay current. It's really their option. And for many, there's a much larger financial incentive to go strategic walk away. We can hate this all we want but the upside down homeowner has a large financial reason to walk away. And now, there's a creative solution.
Don't get me wrong, I hate this and all ideas other then purging the real estate market and flushing all the dead weight out. For me, we will not have a true real real estate market until then. All of these homeowner plans prevent that from happening. But at least this is an industry plan and not a tax payer backed plan.
That being said, the lending community probably has enough data to show this strategy can defer and reduce losses and financially makes sense! Or, it's at least worth trying!
Issues with this plan
Their primary issue like everything in this world is jobs, jobs, and jobs. If that front were turn ugly with unemployment pushing past 10% and we find ourselves in another deflationary leg, then these plans might be worthless in the long run because the savings to walk away would trump the savings to sign up for the plan. Plus higher unemployment would force more people to walk away because no housing payment for a couple years is better than a 10-30% payout when you have no pay check. Jobs and the economy are the true wild card for these lenders and these types of industry programs.
And for the homeowner, there's the risk the mortgage insuring companies go broke and can't pay up in 3-5 years.
Hope all is well.
J.D. Rosendahl, Rosey