A mortgage broker has an idea for reducing foreclosures: Encourage lenders to forgive debt. So far, the notion hasn’t gained traction.
Jeff Lazerson, founder and president of the online brokerage Mortgage Grader, believes that some foreclosures could be prevented if delinquent borrowers could refinance their loans, but with some of the debt forgiven. This type of transaction, called a short refinance or short refi, is rare. Lazerson wants to set up a streamlined system to make short refis more common.
Greatly simplified, this is how a short refinance works: You owe $200,000 on a house that you bought at the top of the market. Since then, house values in your neighborhood have fallen by 20 percent, and your house is now worth $160,000. The rate on your subprime adjustable-rate mortgage has gone up, and you can’t afford the higher payments. Instead of foreclosing, the lender agrees to forgive $40,000 of the debt and refinances the mortgage for $160,000.
“The lenders are going to take a hit anyway,” Lazerson argues. “The biggest thing this does is prevent the number of documented foreclosures happening in a neighborhood and causing the values to deflate. It keeps people in their homes.”
‘No’ from all sides
Lazerson is pushing for his company to be part of the solution. He proposes to have Mortgage Grader negotiate short refinances on behalf of borrowers who otherwise would lose their homes through foreclosure.
The Department of Housing and Urban Development provides funding to some housing counseling agencies, and Lazerson asked HUD to direct those agencies to refer their foreclosure-bound clients to him. Under the proposal, Mortgage Grader would have received $1,495 for each successfully negotiated short refi.
HUD declined because it doesn’t endorse mortgage companies and didn’t have the money. Lazerson approached the Hope Now coalition of housing counselors and mortgage servicers, which turned him down without explanation. The coalition didn’t respond to a request for comment.
The case for short refis
Why should Mortgage Grader make these deals? Lazerson represents his company as one of the good guys — the only for-profit member of the inchoate Fair Mortgage Collaborative, and recipient of a Ford Foundation grant “for an innovative underwriting tool matching primarily low-income and minority homeowners with the least costly mortgage product.”
He has sought a patent on Mortgage Grader’s process, which he says eliminates racial discrimination and “downstreaming” — pushing borrowers into subprime loans when they are eligible for lower-rate prime loans.
Debt forgiveness a rarity
Few bankers will willingly do that, said Michelle Lewis, president of Northwest Counseling Service, an agency in Philadelphia that helps homeowners who are in danger of foreclosure. She says she’s all for negotiating debt forgiveness.
“And that’s been something we’ve been working on for years — but we have had no success,” Lewis says.
She adds that, “occasionally, on a case-by-case basis,” clients have had debt forgiven, but only after filing lawsuits.
There’s no incentive for mortgage servicers to approve short refis, she says, because servicers believe they lose less money by foreclosing than by forgiving debt. And they fear that debt forgiveness would bring out the scammers.
Debt forgiveness isn’t scary, but foreclosure is, and the threat of it keeps homeowners in line. “While we’re seeing mass foreclosures, many (borrowers) are paying under these terms that some would call onerous,” Lewis says.
Government plan benefits few
Last month, the Treasury Department and HUD announced a plan to help homeowners with onerous loans, but not with debt forgiveness.
The plan would aid the small number of people who could afford the introductory rates on their subprime adjustable-rate mortgages, but couldn’t afford the higher payments after the rate jumped. Those people would have their introductory rates frozen for up to five years.
A homeowner taking advantage of the rate-freeze plan will end up making payments on a house that’s worth less than the loan amount.
That’s not necessarily in the homeowner’s best interest. A borrower would pay less every month if some of the debt was forgiven and the loan balance (and monthly payment) reflected the home’s market value.
When you look at it that way, mortgage investors fared quite well in the plan brokered by the secretaries of Treasury and Housing. The rate freeze is friendlier to Wall Street than it is to Elm Street.
“We’ve really got no bailout for consumers, except through individual litigation, which is costly, but the market gets all kinds of bailouts,” Lewis says. “Every effort to correct this leaves the loan whole. All the measures to figure out what to do with the people who got these loans still pay the lender for the bad behavior. It’s crazy.”
In December, even as the Treasury and Housing secretaries pushed a rate freeze instead of debt forgiveness, the president signed a law, called the Mortgage Forgiveness Debt Relief Act, that cuts taxes on homeowners whose debt is forgiven.
“So this bill will create a three-year window for homeowners to refinance their mortgage and pay no taxes on any debt forgiveness that they receive. And it’s a really good piece of legislation,” President Bush said. “The provision will increase the incentive for borrowers and lenders to work together to refinance loans — and it will allow American families to secure lower mortgage payments without facing higher taxes.”
The law might give borrowers a tax break, but contrary to what the president says, it doesn’t provide incentives for lenders to refinance with debt forgiveness instead of foreclosing. The law doesn’t give lenders and mortgage servicers tax breaks or subsidies for approving short refis.