Friday, August 12, 2011

Irvine Housing Blog

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Principal reduction program where debtors take an equity-share position

Posted: 12 Aug 2011 03:30 AM PDT

Ocwen has come up with a new program to forgive principal in exchange for an equity participation interest in future appreciation.

Irvine Home Address ... 38 CARTIER AISLE Irvine, CA 92620
Resale Home Price ......  $449,000

Take a piece of my life
Take a piece of my soul
Take a piece of my face
So I can never grow old

And take a piece of my world
Take a piece of my heart
Take a piece of my brain
So I can never be smart

The Pretty Reckless -- Everybody Wants Something from Me

Borrowers facing foreclosure feel like their lender wants a piece of them. Either they must keep making onerous payments, or they must give up their family homes. Neither option is palatable, but lenders will not provide better options because it will foster moral hazard and irresponsible borrowing in the future.

In the post Foreclosure is a superior form of principal reduction, I noted the following:

Excessive debt is the problem

Ever since the Great Housing Bubble began to deflate, everyone has incorrectly identified the problem as foreclosure. The real problem is not foreclosure, the real problem is that borrowers have excessive debts due to the huge loans lenders underwrote that inflated the housing bubble. Foreclosure is not the problem, it is the cure. Further, there is only one reason foreclosure is seen as the problem: people have to move out of their homes after a foreclosure, and I have demonstrated how private hedge funds and other parties could solve that problem.

One way or another, the banks are going to write down huge amounts of bad debt. Nothing can save them, and we shouldn't try. Principal reductions are the worst possible solution to the problem of excess debt left over from the Great Housing Bubble. Principal reductions merely gives foolish borrowers a pass. If the borrowers go through foreclosure, they have consequences that minimize moral hazard:

  1. Borrowers will be forced to rent, at least for a time.
  2. Borrowers will have reduced access to consumer credit as the foreclosure lowers their FICO score.
  3. Borrowers will have to save and be prudent in order to meet the standards of home ownership and get another loan.
All of those consequences -- inadequate though they may be -- are eliminated if the GSEs merely reduce principal. The borrowers who have the most to gain are those who borrowed most foolishly, and the people paying the price are (1) prudent borrowers and (2) those who didn't borrow at all. Next time around, there will be no prudent borrowers, and everyone will participate. Who is going to pass on free money?

Any program which touts principal reduction has the built-in problem of moral hazard. The less people are punished for their foolish decisions, the more likely they are to repeat them. Further, others witnessing the rewards of the foolish will emulate them in the future. The program discussed today attempts to remedy this problem. I'll let you decide if you believe they are successful.

Ocwen unveils new principal reduction program

by JON PRIOR -- Tuesday, July 26th, 2011, 11:37 am

Ocwen Financial Corp. launched a new modification program to reduce the principal on a mortgage for delinquent borrowers, while compelling them to share in the future appreciation of the home's value with the investor.

When lenders are faced with enormous losses on commercial loans, one alternative they generally consider in lieu of foreclosure is to take an equity-participation position. This provides them the recovery benefit of future appreciation without having to foreclose and take title.

Commercial lenders do this because they don't have the management expertise to run a commercial center, and it is easier to keep a motivated owner in place who will work to make the project successful while it is underwater.

Residential loans are different because it doesn't take any special expertise to own a house, but lenders are considering the same solution because it will allow them to defer recognizing losses, and if they can get the borrower to resume making payments, even at a reduced amount, it may be better than forcing a foreclosure auction and writing down the debt.

Mortgage modifications will only be available for homeowners in negative equity.

No owner with equity would want to give up their future appreciation. Loan owners with high payments but sufficient equity to escape are more likely to sell and move on.

Atlanta-based Ocwen holds a $74 billion servicing portfolio after acquiring Litton Loan Servicing and HomEq. Ocwen launched the Shared Appreciation Modification program as a pilot in August 2010, a program the company believes will make a major dent in the roughly 14 million mortgages currently in negative equity, according to Moody's Analytics.

Another cure-all for the housing market? This program will not make a significant dent in any problem, but it does provide a better alternative for borrowers who want to stay in their homes than current loan modification programs that are merely Option ARMs in disguise.

Through the program, Ocwen will write down qualified loans to 95% of the underlying property's market value. The amount written down is forgiven in one-third increments over three years as long as the homeowner remains current. When the house is later sold or refinanced, the borrower will be required to share 25% of the appreciated value with the investor.

This is really a fair deal for deeply underwater borrowers who would prefer not to leave their homes. Of course, the details matter, and if the loan owner is still making onerous payments, then they still have significant incentive to default. Do the payments drop each year as the loan balance is forgiven?

"Like all modifications, SAMs help homeowners avoid foreclosure. But they also restore equity. That's a significant benefit to the customer and, we believe, the economy and housing market. Psychologically, it's important too," said Ocwen CEO Ronald Faris. "Our analytics tell us that an underwater mortgage is one-and-a-half to two-times more likely to default than one with at least some positive equity."

Negative equity is an oxymoron lenders use to give psychological comfort to borrowers who have nothing. Positive equity is a redundant term that should also be eliminated from proper speech.

Owners with equity generally won't strategically default. Although, i strongly suspect such owners will be more likely to sell immediately once they do have equity because the incentives now favor selling out.

Once the owner is back above water, they can remain in their home and give up 25% of future appreciation, or they can sell their home, buy a comparable property, then keep all future appreciation. What would you do?

I think this will help lenders slowly take their write downs while keeping borrowers paying on underwater properties for three years. In that respect, it helps the bank on both fronts. If these equity participation positions are being sold to investors, I doubt these investors will see much return as most borrowers will sell to get out from under this obligation.

SAM is one of the first principal reduction programs initiated by a private company without the prodding of a government agency. Other servicers have sporadically used Hardest Hit Fund and Home Affordable Modification Program dollars to write down principal, but only in select states.

Since August, Ocwen said 79% of the borrowers accepted the offer with a redefault rate of 2.6%. Ocwen said it has regulatory clearance to push the program into 33 states.

If you give desperate underwater homeowners a lifeline, they will take it. They tout a 2.6% redefault rate over the last year as being low -- and it is much lower than redefault rates on most loan modifications -- but a 2.6% default rates even after principal is reduced is still quite high.

J.T. Smith, the chief investment officer for the boutique investment bank Aristar Funding Group said there are many still unknown parts of how Ocwen will structure the modifications such as tax liens and future title issues, but granting the borrower 75% of the appreciation is "very generous."

Probably too generous. It will be difficult to find investor who want to pay much money for a small portion of appreciation particularly given the high likelihood of early redemption.

"This program is a win for the borrower and very, very generous of Ocwen and investors," Smith said. "Silent seconds are a more equitable solution, so Ocwen borrowers should take these modifications and run with it."

This program will also serve to cut off future HELOC borrowing. The equity share position will undoubtedly be calculated as the difference between the first mortgage and the resale value exclusive of any future encumbrances. It will be very difficult for borrowers to obtain HELOCs as the new lender will be in a third mortgage position subordinate to the equity-share's claim.

Consumer organizations supported the program as well. Marcia Griffin, president of HomeFree-USA, a community-based homeownership development group, called the program "visionary."

"The homeowner benefits from a stable housing situation and the investor is positioned to share in the future appreciation of the home's value. In addition, communities nationwide will benefit from fewer foreclosures," Griffin said.

John Taylor, CEO of the National Community Reinvestment Coalition, said other servicers should follow suit.

This still leaves the question of who pays for this. There is no way the investors are covering the cost of the write down in order to obtain a hoped-for 25% of the recovery. At best, investors in a scheme like that might offer 5% of the amount written off. The lender must still absorb a huge write down to make this program work. The real benefit for lenders is a controlled and measured rate of write down they can budget for.

"This innovative modification program offers meaningful help for underwater borrowers. The simplicity and rationale of the SAM is striking: the homeowner maintains the equity that would otherwise be lost in the foreclosure process, and servicers and investors maintain a performing asset," Taylor said.

A spokesman for Ocwen did not immediately disclose how many borrowers the program is expected to reach.

Write to Jon Prior.

Follow him on Twitter @JonAPrior.

All principal reduction programs contain moral hazard because foolish borrowers are not facing the consequences of their mistakes. Foreclosure is the best form of principal reduction. However, this program does provide some consequences, watered down through they may be. It's a reasonable compromise in a situation with no easy answers.

More HELOC abuse and squatting

The owners of today's featured property borrowed beyond their means, and they have been rewarded with two years of free money and two years of free housing.

  • This property was purchased on 7/21/2003 for $427,000. The owners used a $322,700 first mortgage, a $61,600 second mortgage, and a $42,700 down payment.
  • On 8/27/2004 they obtained a $187,000 HELOC.
  • On 5/16/2005 they obtained another $187,000 HELOC.
  • On 3/30/2007 they refinanced with a $500,000 first mortgage.
  • Total mortgage equity withdrawal is $115,700.
  • Total squatting is at least 28 months.

Foreclosure Record
Recording Date: 02/18/2011 
Document Type: Notice of Sale   

Foreclosure Record
Recording Date: 09/17/2010 
Document Type: Notice of Sale   

Foreclosure Record
Recording Date: 10/07/2009 
Document Type: Notice of Sale  

Foreclosure Record
Recording Date: 07/02/2009 
Document Type: Notice of Default

This property is available for sale via the MLS.
Please contact Shevy Akason, #01836707 

Irvine House Address ...  38 CARTIER AISLE Irvine, CA 92620
Resale House Price ......  $449,000

Beds:  3
Baths:  3
Sq. Ft.:  1764
Property Type: Residential, Condominium
Style: Two Level
Year Built:  1989
Community:  Northwood
County:  Orange
MLS#:  P791767
Source:  SoCalMLS
Status:  Active
On Redfin:  1 day
Largest Model W/ Main Floor Bedroom/Full Bath, Private Tropical Gated Front Courtyard Entry, Open & Spacious Floorplan W/ high Vaulted Ceiling & Lots of Windows, Huge Master Suite W/ High Volum Ceiling, spacious Kitchen w/ Lots of Cabinets, Seperate Breakfast Nook Area, Wood Flooring Downstairs, Private Location, Very Low HOA, No Mello Roos, Close to Everythings. 
Proprietary IHB commentary and analysis 

Close to Everythings? High Volum Ceiling? Seperate?

Resale Home Price ......  $449,000
House Purchase Price … $427,000
House Purchase Date .... 8/7/2002

Net Gain (Loss) .......... ($4,940)
Percent Change .......... -1.2%
Annual Appreciation … 0.6%

Cost of Home Ownership
$449,000 .......... Asking Price
$15,715 .......... 3.5% Down FHA Financing
4.31% ............... Mortgage Interest Rate
$433,285 .......... 30-Year Mortgage
$126,492 .......... Income Requirement 

$2,147 .......... Monthly Mortgage Payment 
$389 .......... Property Tax (@1.04%)
$0 .......... Special Taxes and Levies (Mello Roos)
$94 .......... Homeowners Insurance (@ 0.25%)
$498 .......... Private Mortgage Insurance
$140 .......... Homeowners Association Fees
$3,268 .......... Monthly Cash Outlays

-$340 .......... Tax Savings (% of Interest and Property Tax)
-$591 .......... Equity Hidden in Payment (Amortization)
$25 .......... Lost Income to Down Payment (net of taxes)
$76 .......... Maintenance and Replacement Reserves
$2,437 .......... Monthly Cost of Ownership 

Cash Acquisition Demands
$4,490 .......... Furnishing and Move In @1%
$4,490 .......... Closing Costs @1%
$4,333 ............ Interest Points @1% of Loan
$15,715 .......... Down Payment
$29,028 .......... Total Cash Costs
$37,300 ............ Emergency Cash Reserves
$66,328 .......... Total Savings Needed

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