A brand new loan modification initiative that's aimed specifically at home equity loan products has just been launched by the Obama administration. The program hopes to alleviate the burden of second mortgages, and offers financial incentives for lenders who successfully rework bad loans.

Expanding upon the reach of its $75-billion Making Home Affordable loan modification and foreclosure prevention plan, the Obama administration is now targeting second mortgages. By offering financial incentives to banks and other lenders, the hope is that homeowners will finally be able to relieve themselves of burdensome second mortgage payments. Those home equity lenders who succeed at reworking second mortgage products-by doing such things as lowering interest rates, extending payments, or slashing principal balances-will be rewarded with payments from the government.

Loan modification perks

According to the guidelines of this newly conceived plan, lenders will receive $500 for modifying a customer's second mortgage. They can also earn rebates or rewards of $250 a year for the next three years, as long as the borrower stays current on the loan. The borrower will also be eligible to have $250 applied to his principal balance to help lower it, and he can get these funds for up to five years. Homeowners can also qualify for interest rates of just 1 percent on some types of home equity loans, and the government will help to subsidize those low rates by sharing their costs. The money to pay for subsidies and incentives comes from bailout funds that were previously set aside to help stabilize the faltering economy.

Home equity loan burdens

The new initiative was launched two months after the start of the Making Home Affordable program. Although the original program is helping some homeowners, many borrowers are saddled by second mortgages, which have proven to be serious obstacles to loan modification. A homeowner may only owe a small amount on his home equity loan, for example, but that outstanding debt may prevent him from being able to rework his larger first mortgage. As a result, many homes are being lost to foreclosure, thanks to a relatively small obligation in the form of a home equity loan that stands in the way of loan modification. Approximately half of all at-risk homeowners carry a second mortgage, and many of them took those out to help pay closing costs or down payments while using exotic and hazardous no-money-down loans trumpeted during the recent real estate bull market.

Many industry observers are skeptical that the financial incentives aren't nearly enough to stop foreclosures, since investors who funded mortgages stand to lose many times the amount of these relatively small cash rewards offered by the federal government under various incentive programs. So far, all of the government loan modification strategies have asked for voluntary, not compulsory, lender participation. Lenders are beholden to their investors, however, and many of the investors holding liens on second mortgages refuse to release them in order to facilitate reworking of primary first mortgages.

Published on June 4, 2009