Second mortgages complicate efforts to help homeowners

Second mortgages complicate efforts to help homeowners

Saturday, April 1, 2010



As government regulators and lenders work to stabilize the housing market, one of the factors that helped propel the housing boom of the past decade is now taking a central role in thwarting their efforts: second mortgages.
Programs to help distressed borrowers so far have focused on lowering the payments on their primary mortgage. But during the go-go years of the housing market, millions of homeowners took out a second or even third loan backed by their home. Many were piggyback mortgages, which enabled home buyers to put little or no money down, while others took advantage of rising home prices to secure home-equity lines of credits.
Now, these secondary loans are aggravating the foreclosure crisis, adding an extra burden that can be the difference between borrowers digging out of debt and losing their home. The extra mortgages also make it far more unwieldy for lenders to untie the knot of excessive debt and provide relief to borrowers. And even when borrowers do get help with their primary mortgages, the second loans can continue to bedevil homeowners, raising the risk they will default later.
A new effort
The Obama administration is about to ramp up its efforts to tackle second mortgages as part of an aggressive program announced by the White House on Friday to address foreclosures. Other steps include a requirement that lenders offer temporary mortgage relief to unemployed borrowers and increased incentives for lenders to cut loan balances for borrowers who owe more than their homes are worth.
Government officials have estimated that about 50 percent of troubled borrowers have a second mortgage. But a year after federal officials launched an initial program to lower payments on these second loans, not a single homeowner has been helped. The efforts have been hamstrung by technical challenges, the competing interests of the banks that hold the first and second mortgages and a reluctance among some major financial firms to take heavier losses, according to economists and housing analysts.
"Second liens, boy, that's tough," Federal Deposit Insurance Corp. Chairman Sheila C. Bair said in a recent interview. "That has been a thorn in everybody's side."
As part of the new program, the government will double the amount of money it can pay lenders to forgive part of a borrower's second loan or wipe it out altogether. Administration officials say many of these mortgages would be worthless if borrowers were forced into foreclosure, so it is in the lenders' interest to settle for less than full repayment.
The problem posed by second mortgages has even prompted Blackrock, a huge asset-management firm that manages billions of dollars in first-lien mortgages, to lobby lawmakers with a plan that would allow bankruptcy judges to modify troubled borrowers' debts, including home loans. That puts Blackrock at odds with much of the financial services industry, which last year helped kill a similar proposal in the Senate.
But Blackrock argues that bankruptcy courts working with new guidelines could take into account all of borrowers' debts, in contrast with most loan-modification programs, which address only primary mortgages.
The debt burden
The shortcomings of the current approach are exemplified in the government's marquee foreclosure-prevention initiative, known as Making Home Affordable. Under that program, lenders are paid to lower borrowers' primary-mortgage payments to 31 percent of their income. But even after this relief, borrowers still spend on average 60 percent of their income on their debts overall, including their second mortgages, credit cards and car payments, according to Treasury Department data.
That is the challenge facing Sarah Ferrell. She spent six months securing a loan modification for her Phoenix home, lowering the payments to about $700 a month from $1,200. But she owes another $300 a month on her second mortgage, a home-equity loan. Ferrell said she still can barely break even each month and will continue to use credit cards for some essentials. "It was really a blessing to get this help, but it didn't fix everything," she said.
And down the road, difficulties could mount further for homeowners like Ferrell. After five years, the interest rate on mortgages modified under the federal program begins to rise.
These homeowners could re-default later under the combined weight of these multiple mortgages. Second mortgages have also stood in the way of efforts to help millions of borrowers who have seen their home values plummet and now owe more than their property is worth.
"To really address the affordability issue you have to deal with subordinate liens," said Micah Green, a partner at the law firm Patton Boggs who represents large investors in mortgages. "You have to look at the total debt picture facing the homeowner."
And for some homeowners, the second lien can haunt them even after they lose their home. Eric Davis bought his Lorton home for $330,000 in 2005 by securing two loans, one covering 80 percent of the balance and a second mortgage covering the rest.
After failing to secure a loan modification last year, Davis got his first lender to agree that he could sell the house for $203,000 in what is called a short sale and turn over the proceeds. But Navy Federal Credit Union, which holds his second lien, netted only about $5,000. He still owes the firm nearly $60,000. Bankruptcy is now inevitable, Davis said.
"It's not like we're holding anything back," Davis said. After a car accident last year, he works just one of the two jobs he had held to keep up his payments. "I am not putting anything in retirement, and I warned them my wife is pregnant and due in June, which will make it even more difficult to keep up," he said. ". . . Even without paying them, we're going to be struggling."
Jack Gaffney, executive vice president of lending at Navy Federal, said the credit union tries to negotiate loan modifications with distressed borrowers to keep payments coming. "If they do have a job and the ability to pay, we do expect them to repay their obligation to the membership," he said.
The administration has been grappling with the second-lien issue for nearly a year. In April, officials announced a program encouraging lenders to lower the interest rate on borrowers' second mortgages to 1 percent or even wipe them out in some cases.
Just a few banks hold most of the second liens, according to data from Inside Mortgage Finance. Of the more than $840 billion in home-equity lines and piggyback loans outstanding, Bank of America has about $147 billion of them, while Wells Fargo and J.P. Morgan Chase have $124 billion and $118 billion of the market, respectively. Citigroup has about $53 billion of these loans on its books.
They have all signed up for the administration program announced last year, but none has taken action yet.
"It took a while for this program to get to its final form to get, to a place where everybody is satisfied, but we're looking forward to helping customers," said Kevin Moss, an executive vice president at Wells Fargo.
Treasury officials say the program is making progress, and industry representatives say they already modify some second mortgages on their own.
Paying the smaller loan
But some lenders are reluctant to take a loss on these loans if borrowers are still paying, industry analysts said. And some borrowers keep paying second loans even as they head into foreclosure. That's because the payments are usually significantly cheaper than those on a primary mortgage. Also, a borrower's home-equity line of credit can provide cash during a financial pinch, the analysts said.
"The reality of the situation is that the payments on the second are so much smaller and they [borrowers] don't want to default on everything," said Guy Cecala of Inside Mortgage Finance.
A rift has opened between the holders of first and second liens. Many primary mortgages were sold to investors, and they might be more willing to write down borrowers' principal if holders of second liens took a similar hit, according to analysts and industry officials.
Investors holding first liens complain that they are unfairly bearing the brunt of the cost of the foreclosure crisis. Traditionally, holders of second liens take a loss before creditors who hold first liens. But loan-modification efforts have reversed that.
"In order to remedy the current problem, new standards should set protocol on seconds being extinguished prior to firsts being modified," said Nancy Mueller Handal, a managing director at MetLife, which services $44 billion in residential mortgage securities.