Fed Governor Lists Steps to Remedy Subprime Distress
With subprime mortgage delinquencies and foreclosures possibly getting worse before they get better, “a high degree of collaboration and innovation to identify solutions” is needed to help borrowers keep their homes, Federal Reserve Governor Randall S. Kroszner told NAHB’s Symposium on Housing Affordability on Nov. 5 in Washington, D.C.
“It is imperative that we work together as a financial services community to look for ways to help borrowers address their mortgage challenges, particularly those who may have fewer alternatives, such as lower-income families,” Kroszner said.
Distress among subprime borrowers has been concentrated in the variable-rate mortgages that constitute two-thirds of that market, he said, and more than 17% of those loans are now more than 90 days in arrears, a tripling of the share since mid-2005.
Contributing greatly to the problem are resets after the initial two- or three-year phase of the mortgage that are significantly increasing interest rates and monthly payments.
“In early 2007, the typical subprime mortgage experiencing a first reset had its rate increase from 7% to 9.5%, producing an increase of 25% to 30% in the monthly payment,” Kroszner told the symposium. “This increase translates into an additional monthly debt obligation of $350 per month for the average subprime variable-rate mortgage."
With the appreciation of home values slowing to a virtual crawl from the rapid escalation of the housing boom years, or even declining in some markets, subprime borrowers, many of whom purchased their homes with little or no money down, don’t have enough equity to avoid payment increases by refinancing.
About two-thirds of subprime borrowers who in 2003 and 2004 took out adjustable rate loans that are reset after two years were able to avoid higher payments by refinancing or selling their home before the first scheduled reset, he said. “Prepayments on subprime variable-rate loans originated in late 2005 and 2006,” the tail end of the boom, “have occurred at a slower pace,” he said.
“The bulk of resets is yet to come,” Kroszner warned. “On average, in each quarter from now until the end of next year, monthly payments for more than 400,000 subprime mortgages are scheduled to undergo their first rate reset. That number is up from roughly 200,000 per quarter during the first half of 2007. Delinquencies and foreclosures are therefore likely to continue to rise for a number of quarters.”
Kroszner said that the Federal Reserve’s Community Affairs Offices have been convening lenders, community leaders and government officials around the country over the past two years to help identify strategies to provide resources to assist borrowers confronting foreclosure.
The Fed, he said, has also been urging mortgage lenders and servicers to look for ways to work with borrowers who are having difficulty in paying their loans — including loan modifications, deferral of payments, extension of loan maturities, capitalization of delinquent amounts and conversion of adjustable-rate mortgages into fixed-rate mortgages or fully indexed, fully amortizing adjustable-rate mortgages.
Among initiatives recommended by participants at the symposium to address current affordable housing needs would be allowing state housing finance agencies to provide refinancing for strapped subprime borrowers.
While there is no comprehensive data available, Kroszner said reports suggest that the number of loan workouts and modifications that have actually occurred “may be limited thus far.”
“One possible contributing factor is that many borrowers are not seeking help or advice from their lenders because they believe that lenders cannot or are not willing to help them. Industry and consumer advocates who testified at our hearings on the home equity lending market last year told us that the greatest barrier to working with troubled borrowers is in simply making contact with them.”
Among national organizations and initiatives that are making headway in helping to resolve problems with troubled loans, he cited:
- NeighborWorks America (NeighborWorks) and its Center for Foreclosure Services and 1-888-995-HOPE hotline. The hotline has received more than 100,000 calls this year, more than half in the third quarter.
- The Hope Now alliance. “This collaboration among counselors, servicers, investors and other mortgage market participants aims to increase outreach efforts to contact at-risk borrowers through a national direct-mail campaign, encouraging them to either call their lender or a credit counselor.”
- Foreclosure Prevention Working Group. “Consisting of 11 state attorneys general plus the Conference of State Bank Supervisors and the state bank regulatory agencies, the Working Group has held conversations with mortgage servicers and will continue to pursue opportunities for preventing foreclosures and encouraging increased loan modifications.”
“All these efforts are important,” Kroszner said, “but there is more to be done to deal with the significant challenges ahead.” Among the innovations that are needed:
- “First, at this point, we are hearing that many modifications are done on a case-by-case basis,” he said. “That is understandable given the complexity of the products and the unique circumstances of each borrower. Given the substantial number of resets from now through the end of 2008, however, I believe it would behoove the industry to join together and explore collaborative, creative efforts to develop prudent loan modification programs and other assistance to help large groups of borrowers systematically.”
- “Second, I believe that modernization of programs administered by the Federal Housing Administration, which has considerable experience helping low- and moderate-income households obtain home financing, could also help avoid foreclosures,” he said. “FHA modernization could give the agency the flexibility to work with private-sector lenders to expedite the refinancing of creditworthy subprime borrowers and to design products that improve affordability through such features as variable maturities or shared appreciation.”
- “Third, we must pursue initiatives to prevent these problems from recurring, and the Federal Reserve is making strides in this direction.” Before the end of the year, he said, the Fed will be issuing proposals to ban deceptive advertising and require important consumer disclosures early in the mortgage process. The Fed will also address practices associated with subprime lending, such as prepayment penalties, failure to offer escrow accounts for taxes and insurance, stated-income and low-documentation lending and the failure to give adequate consideration to a borrower’s ability to repay.