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December 4th, 2009

Loan Mods: Just Another Exotic Loan?

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In the middle of October, we wrote two blog posts that seriously called into question the effectiveness of the Home Affordable Modification Program (HAMP). In addition to magnifying the program’s inabilities, our two articles also highlighted a wealth of HAMP’s “unintended consequences.” While the two articles addressed different specifics, the general theme behind them both was the same: HAMP is flawed.

Are Loan Mods Destroying the Mortgage Industry?
Update1 Is it Time to Modify Modifications?

Despite all the criticisms we’ve dished out about HAMP, we’ve never referred to it as an “exotic mortgage.” Sean O’Toole of ForeclosureTruth.com wrote a blog post this week that claims the administration’s drive to produce more permanent loan mods is an effort in selling homeowners “the most exotic mortgage yet.” The fact that interest-rate reductions under HAMP last for only five years (then incrementally increase after that) causes O’Toole to charge that Washington is merely delaying the inevitable by offering these exotic loans:

[HAMP is] only digging them a new one, and delaying the inevitable.

The original hole was created with a clear downside and a theoretical upside:

  • The downside: exotic financing, that qualified buyers for homes they clearly couldn’t afford by offering a low payment up front, despite unaffordably high payments in the future.
  • The upside: the expectation that the appreciated value in the house will allow the borrower to refinance or sell at a profit before their payment skyrockets.

The new hole offered by HAMP is all the downside with none of the upside.

  • The downside: exotic re-financing, by which they make payments affordable today, but leave homeowners in the same boat down the road when payments ratchet back up after 5 years.
  • The bonus downside: there is no reasonable expectation that home values will appreciate anywhere near enough to get these loans above water before the 5 years is up, or before the homeowner runs into a real life event like job loss, divorce or job relocation – leaving them stuck in an upside down prison of debt.

Yet, are these modified loans really exotic? According to the HAMP guidelines, the structure for the interest rate increase after five years is pretty clearly defined. “The modified interest rate must remain in place for five years, after which time the interest rate will be gradually increased 1% (100 basis points) per year or such lesser amount as may be needed until it reaches the Interest Rate Cap.” The interest rate cap is defined as the fully indexed and amortized original contract rate or the Freddie Mac rate at the time of the modification. Can a loan be considered exotic if a borrower can fully calculate their monthly payments for the remaining period of their loan?

In conclusion, do we think modifications are complicated? Sure. Do we think they are exotic? Not necessarily.

O’Toole’s “exotic” notion has received quite a bit of attention so far as it was just recently picked up by our friend Nick Timiraos over at the Wall Street Journal. Sometimes you think you’ve said all there is to say on a subject, then you read another introspective assessment like this. O’Toole’s blog post is definitely worth a read.

Would you consider a modification an exotic mortgage?

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2 Responses to “Loan Mods: Just Another Exotic Loan?”

  1. Sean OToole Says: December 5th, 2009 at 3:53 am

    Those who claim these aren’t exotic have missed that fact that many mods are at 150 to 200% loan to value — there simply is no limit as to how upside down the home can be. Sorry I wasn’t more clear about that in my post. Bottom line is that 150% LTV loans with a 5 Year “teaser rate” are far more exotic than anything offered in the bubble years.

  2. Tim Manni Says: December 8th, 2009 at 3:23 pm

    Sean,

    According to MakingHomeAffordable.gov, your LTV can’t exceed 125% for both mods and refis. Are you referring to private lenders who are operating outside making home affordable offering mods for over 125%, because we haven’t heard too much about 150 and 200% LTV mods?

    Thanks,
    Tim

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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