By connecting families with financial assistance from the now-ended federal Making Home Affordable program as well as other low-cost refinance loans, second mortgages and emergency loans, state or local housing finance agencies can help homeowners avoid foreclosure and stay in their homes at a monthly mortgage payment they can afford.
Collaborate with lenders and servicers on behalf of borrowers
To ensure that lenders or servicers prevent foreclosure for troubled borrowers, some state governments have entered into agreements directly with the servicers and strengthened regulations to enable more borrowers to get long-term and sustainable loan modifications.
Loan modifications fall into two main categories. Modifications can reduce the size of monthly payments for a homeowner, either through an interest rate reduction, principal reduction or extension of the term of the loan. These modifications are sometimes called concessionary. Concessionary modifications provide long-term relief and are the most effective at preventing foreclosure in most cases.
Other loan modifications provide temporary relief to the homeowner – temporary forbearance, for example, allows the homeowner to miss one or more payments during a time of hardship. However, the missed payments are recapitalized into the balance of the loan, increasing payments in the long run. This type of modification is only effective in limited circumstances in which the borrower has a temporary hardship and an ongoing ability to afford higher monthly payments in the near future.
It is worth noting that while loan modifications may help many families, they are not a panacea. Since many predatory lending practices provided mortgages without requiring verification of the borrowers’ income, many families got home mortgages they could not afford in the first place and would be unable to afford with any reasonable level of loan modification. Research has shown that loan modifications need to make the monthly payment more affordable in order to be successful. A policy alternative in some cases could be to use intensive, short-term aid to keep families in their homes.
Additionally, policies that aim to ease the process of loan modifications or mortgage refinance to keep families in their homes must be carefully crafted to ensure they are feasible for borrowers, lenders and servicers. This may entail offering a package of programs to help with temporary financial crises, unaffordable mortgage terms and negative equity that impedes refinance — all while considering underwriting standards and servicers’ obligations to investors. Assistance through the federal Hardest Hit Fund and Making Home Affordable programs included loan modifications, refinance and emergency assistance loans. Between April 2009 and February 2014, 1.3 million homeowners received permanent modifications under the Home Affordable Modification Program.
Offer a range of suitable refinancing products and emergency loans
A number of state and local housing finance agencies have developed special loan products to prevent foreclosures among families that cannot qualify for traditional refinancing products and have not been able to modify their existing loans to make them more affordable. Foreclosure prevention loans take a variety of different forms that all aim to help families stay in their homes whenever possible. Depending on local needs and resources, this may involve silent second mortgages and shared appreciation loans, low-interest refinance loans and short-term emergency loans.
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Short-term emergency loans
In cases of temporary financial hardship, a small amount of assistance may make a large difference for a family. Housing finance agencies can craft these emergency loans to meet local needs and economic realities. Small and/or short-term loans are not capable of preventing foreclosure for every family, but they play an important role in a community’s overall foreclosure prevention strategy by helping families stabilize their finances before delinquencies get out of control. Temporary financial assistance products are often designed to help families retain stable housing during unemployment or sudden losses of income. During the Great Recession, unemployment problems lasted for extended periods of time. The assistance provided by short-term loan programs was similar to deeper assistance approaches, such as silent second mortgages.
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Make low-interest refinance loans available
State Housing Finance Agencies (HFAs) have often offered low-cost loans to help homeowners refinance mortgages with high interest rates or other nontraditional terms. Typically, state or local refinance loans offer financial assistance for borrowers who have relatively good credit, are not seriously delinquent on their mortgages and do not owe more than the value of their homes (a situation known as negative equity or being underwater). The moderate level of financial assistance provided by most refinance loans can be a strong tool for preventing foreclosure among credit-worthy families that ask for help in the early stages of their mortgage affordability problems. Unfortunately, many refinance programs have been discontinued.
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Refinancing with flexible underwriting requirements, silent second mortgages or shared appreciation loans
Many families facing foreclosure are unable to refinance since the drop in home values has left them owing more than the current value of the home; in addition, late or missed mortgage payments will have negatively impacted borrowers’ credit score. To prevent foreclosures among families in deep financial distress, communities may wish to seek innovative solutions that go beyond standard refinance loans and short-term emergency assistance.
Understanding how to structure refinancing options
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Flexible underwriting standards
As the foreclosure crisis escalated, financial assistance programs began offering foreclosure prevention loans with flexible underwriting standards to help borrowers with lower credit scores – including scores in the mid or low 500s – provided that mortgage delinquency is the borrower’s most serious credit problem. Programs may have no minimum credit score and consider instead the number and length of delinquencies.
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Silent second mortgages
Communities are also thinking creatively about how to structure loans to prevent foreclosure among families that cannot qualify for more traditional refinancing — either because they cannot afford a refinanced loan at the current mortgage level or because they owe more than their home is worth. One approach to addressing these problems is to refinance for a traditional mortgage at a level that is affordable and supportable by the home’s current property value and then issue a silent second mortgage to cover the difference between that amount and the current mortgage balance. With a silent second mortgage, the family makes no payments of principal or interest while living in the home, but must repay the second mortgage when they sell or refinance. A silent second mortgage allows the family to continue living in the home and make affordable monthly mortgage payments on the refinanced first mortgage, while also ensuring that the loan provided by the community is repaid if the property sells for more than the first mortgage amount at the time of eventual resale.
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Shared appreciation second mortgages
A different silent second mortgage option that communities may wish to consider is a shared appreciation mortgage. Shared appreciation refers to the repayment agreement for the loan. Upon resale of the home, the family pays back a predetermined portion, or share, of the net sales proceeds. In some cases, the family first pays back 100 percent of the principal balance of the shared appreciation mortgage and then pays a set share (for example, one-quarter) of any additional home price appreciation. In other cases, to preserve the family’s incentives to keep up the home and maximize the home sales price, the family simply repays a share (e.g., 75 percent) of the net home sales proceeds, rather than making separate payments of principal and appreciation.
The shared appreciation approach has several benefits. First, it allows families to stay in their homes at a monthly payment they can afford. Second, it provides a means for reimbursing the government or the lender for the costs associated with providing the second mortgage. Third, it preserves the incentives for the family to keep up the property and realize as high as possible a sales price. Finally, since the repayment of the second mortgage is based on a share of the sales proceeds rather than a set interest rate, it avoids the problem of the family owing more than the value of the home.
Under a shared appreciation approach to foreclosure prevention, a mortgage held by an at-risk borrower is split into two mortgages. The first is a standard 30-year fixed-rate mortgage with payments at a level the family can afford. The balance of the original mortgage is converted into a silent second mortgage in which no payments are due until the home is resold (or refinanced). Upon sale of the home, the buyer repays the primary mortgage (the 30-year fixed-rate mortgage), plus a share of the remaining proceeds, which goes to satisfy the silent second mortgage.