Is Obama's Loan Modification Program too Complex?

Net present value tests, sticky eligibility requirements, and potential legal challenges make for a complicated loan modification program.

Two trains leave Union Station in L.A. at the same time, heading in different directions. One arrives in San Francisco in half the time it takes the other to get to El Paso; what are the average speeds of each train? Once you figure that problem out, you might be warmed up enough to try to figure out Obama's new loan modification program.

The "Making Home Affordable" program

When the Obama administration announced its new Making Home Affordable program in early March, the initial reaction from lenders was confusion. Apparently, the two-pronged plan was too much to absorb right away, as desperate homeowners asked questions faster than lenders could find answers.

There are two primary components of Making Home Affordable-the Home Affordable Refinance, and the Home Affordable Modification. Here's a quick look at the loan modification side of the program.

Loan modifications to avert foreclosures

Delinquent mortgages will be deemed eligible or ineligible for loan modifications by a net present value test. Basically, the loan servicer will have to compare the net present value of the mortgage before modification to the net present value of the modified mortgage.  If the net present value of the modified mortgage is higher, the servicer will be required to perform the loan modification-that is, as long as the servicer is contractually allowed to do so.

The modified mortgage payment can be no greater than 31 percent of the borrower's gross monthly income. This payment level will be achieved through various actions, including interest rate reductions, lengthened amortization schedules and, lastly, debt write-offs. The servicer, lender, and investor must absorb the cost of bringing the payment down to 38 percent of the borrower's income.  The program then shares the cost of lowering the payment from 38 percent to 31 percent of income.

Modified mortgage complications

Before the program can begin running efficiently, loan servicers will have to master the net present value tests and understand the eligibility requirements.  Borrowers, for example, have to document income with an IRS Form 4506-T, pay stubs, and a tax return. They also have to execute an affidavit to verify financial hardship. Borrowers who are already paying on a modified mortgage can qualify-but they can only modify their mortgage one time under this program.

The other issue is the legal authority of servicers to modify loans. This point is one that has plagued previous modification efforts, including Hope for Homeowners.  Servicers who modify mortgages without investor approval may be opening themselves up to litigation. Some investors have threatened as much, and servicers are pressuring the feds to offer some type of safe harbor legal protection.

The administration believes that the loan modification program can avert 3 to 4 million foreclosures. Unfortunately, the initial reaction of lenders, servicers, and investors indicates that the program ramp-up may be somewhat slower than the train traveling from L.A. to El Paso.