In November, Federal Housing Finance Agency (FHFA) Director James B. Lockhart announced the beginning of a loan modification program whose impact will ripple through every shop that services agency-held paper.
Dubbed the Streamlined Modification Program (SMP), the FHFA initiative aims to restructure troubled Fannie Mae and Freddie Mac loans – together, the two government-sponsored enterprises (GSEs) own notes that represent about 20% of all serious delinquencies in the U.S. – by delegating executive authority to servicers.
The SMP borrows heavily from several concepts found within the Federal Deposit Insurance Corp.'s systematic modification approach in use at IndyMac – most notably, the target debt-to-income (DTI) ratio of 38% or less – and according to Lockhart, it is meant for the ‘highest-risk borrowers.’
To ensure a smooth implementation, Fannie Mae and Freddie Mac released formal SMP guidelines for servicers in mid-December, including details on acceptable valuation methods and how to calculate payments. The following is an overview of Fannie Mae's SMP regulations.
To aid servicers in identifying potential modification candidates, Fannie Mae provides specific borrower and mortgage eligibility requirements. The program applies to first mortgages originated on or before Jan. 1, 2008, that are at least three full payments past due (or six payments past due for biweekly loans).
The notes must have mark-to-market loan-to-value (LTV) ratios equal to or greater than 90%. Fannie Mae prohibits servicers from using an automated valuation model in determining the LTV. The loan also cannot be insured or guaranteed by a federal government agency, such as the Federal Housing Administration.
The property securing the mortgage must be a one-unit principal residence that is not vacant, abandoned or in severe disrepair. The borrower cannot be involved in another workout plan relating to the applicable loan, nor can he or she be involved in a bankruptcy proceeding or non-foreclosure litigation regarding the mortgage.
Fannie Mae outlines, step by step, the accepted method of determining a borrower's new payment amount under the SMP. First, the GSE instructs servicers to capitalize accrued interest, out-of-pocket escrow advances and costs – if allowed by state law – adding that late fees and penalties cannot be capitalized. Next, the loan term can be extended by up to 40 years from the payment date that follows the three-month trial period. (Negative amortization is prohibited.)
The third step requires adjusting the interest rate (which is to be no lower than 3%), and Fannie Mae offers specific directions for handling adjustable-rate mortgages. To determine the market interest rate, servicers should consult the most recent Freddie Mac Weekly Primary Market Survey Rate for conforming loans.
If the note rate is below the market rate, it should be reduced in increments of .125% until the 38% DTI is reached. The reduced rate can be used for no longer than five years, at which point it increases by 1% per year until reaching the maximum interest rate (i.e., the note rate in effect on the date the SMP agreement is prepared). That maximum interest rate is then fixed for the modified loan's life.
The same .125% incremental reduction rule applies to notes with a rate that is above the market rate. If the resulting rate is at or above the market rate, it becomes fixed; if not, then Fannie advises servicers to follow the same 1%-per-year reduction process.
If the payment ratio is still not 38% or less after the first three steps have been taken, servicers can opt for principal forbearance. If this route is chosen, Fannie Mae encourages servicers to list the gross unpaid principal balance on monthly statements sent to the borrower. Principal write-downs or forgiveness is forbidden.
The GSEs have also made available the SMP Workout Calculator, which servicers will be able to access on the Home Saver Solutions Network.
Modifying the loan
Servicers may contact borrowers to let them know about the SMP, regardless of whether the servicer has recent borrower financial information. If the servicer possesses such information, an offer solicitation – including the SMP cover letter, agreement and a Hardship Affidavit – may be mailed.
If no recent financial information is available, the servicer may still send a solicitation letter. Fannie Mae additionally recommends that servicers refrain from referring a loan to foreclosure until the deadline to respond to a solicitation has passed.
A potential hurdle in the modification process may be found in Fannie Mae's failure, thus far, to obtain ‘blanket delegations of authority’ from all mortgage insurers. The GSE says it is working toward achieving such approval, but until that occurs, servicers must work with insurers on each individual situation.
Once the SMP agreement has been sent to the borrower, he or she has a 14-calendar-day time frame in which to sign and return the document. Along with the signed agreement should be verification of income, a signed Hardship Affidavit and the first of three trial-period payments. If the deadline is nearing and no signed agreement has been received by the servicer, Fannie Mae urges borrower contact.
The trial period is meant to allow servicers and borrowers the opportunity to determine whether the modified loan is reasonably sustainable. Assuming the borrower makes the three trial-period payments, the actual modification becomes effective on the first day of the fourth month following receipt of the SMP agreement.
However, with mortgage-backed security loans, the note must be removed from the MBS pool before the modification's effective date. Fannie Mae emphasizes the importance of diligent reporting to Fannie Mae for the purpose of loan reclassification requests.
The SMP is complex, and given its sweeping but systematic approach, questions are sure to arise. But there remains little doubt that the FHFA expects the program – as the GSEs' largest foreclosure-prevention effort announced to date – to be leveraged widely by servicers.