U.S. to force private investors to modify mortgages

A federal program that sold more than 100,000 soured mortgages to private investors at discounted prices is getting a major overhaul.

Changes announced by federal housing officials on Thursday follow months of criticism from legislators and housing advocates that the buyers of the loans have not done enough to keep struggling borrowers in their homes.

The housing officials said that private investment firms buying delinquent mortgages would have to consider reducing the total amount of money owed on a mortgage as part of a potential modification to make a loan more affordable.

The requirement that private buyers — mostly private equity firms and hedge funds — will have to consider things like principal reduction in reworking troubled mortgages represents a significant change in a government program that began in earnest four years ago in the wake of the housing crisis.

Edward L. Golding, principal deputy assistant secretary with the Department of Housing and Urban Development, said the housing agency was deeply committed to protecting struggling homeowners and making certain they have the greatest opportunities to avoid foreclosure and remain in their homes.

Federal officials also said they would make it more difficult for private buyers to temporarily reduce the interest rate on a mortgage only to have it revert to the original terms after five years, a practice used by some private buyers.

The changes in the program are intended to address criticism that the sale of distressed mortgages — while resulting in better loan terms for some borrowers — did not come with specific directions outlining the steps the buyers should take to make the mortgages more affordable.

The revisions address most of the main concerns of housing advocates. But it is not clear how lasting the impact will be, given that they are coming in the last few months of the Obama administration.

Too late for 105,000 mortgages

The new rules will not apply to the more than 105,000 mortgages already sold by HUD in a series of auctions. The first batch of mortgages to be governed by the new rules will not be sold until September.

Still, federal officials expect many more sales of troubled mortgages that were guaranteed by the Federal Housing Administration, a division of HUD, as there are still hundreds of thousands of borrowers who are delinquent on their payments — even though much of the housing market has recovered from the financial crisis.

I expect this type of note sales will be part of the toolkit that will be involved going forward, the HUDs Golding said.

Bought at sharp discount

To date, HUD has auctioned off mortgages to more than a dozen private buyers who have bought the loans at a sharp discount to their face value.

Two of the largest buyers of distressed mortgages have been Lone Star Funds, a private equity firm based in Dallas, and Bayview Asset Management, a firm affiliated with the Blackstone Group, one of the world’s largest private equity firms.

Until now, HUD officials had argued that the loan sale program was the last best chance to keep delinquent borrowers in their homes. The loans sold by the government are ones that were originally written by large banks with insurance guarantees by the federal government and have been delinquent for about two years.

The loans sale have been most successful in reducing the cost to the government of guaranteeing those mortgages against a default because, once the loans are sold, they are no longer insured by the FHA’s mortgage insurance fund.

Private equity missteps

But an article in The New York Times on Lone Star’s handling of a pool of 17,000 delinquent mortgages revealed that the private equity firm and its wholly owned mortgage servicing firm had been aggressive in pushing thousands of borrowers toward foreclosure. Lone Star’s mortgage firm, Caliber Home Loans, has tended to offer deals that allow little room for negotiation and do not include principal reduction.

The Times also found that one type of modification offered by Caliber was a five-year deal during which a borrower made either reduced monthly payments or simply paid interest on the loan. But those modifications revert to their original payment terms in the sixth year, sometimes with any deferred unpaid principal or unpaid interest added to the back end of the loan.

Those types of modifications are likely to be prohibited under the new rules that HUD says are intended to provide struggling borrowers with payment shock protection.

Smaller pools of mortgages

Other new measures announced by housing officials would make it easier for nonprofit and community groups to buy loans by creating smaller pools of mortgages that are cheaper to bid on and simplify the process for local governments to buy distressed loans.

HUD is setting a goal of selling 10 percent of all mortgages to either nonprofit organizations or local government agencies.

Buyers also will be barred from abandoning hard-to-sell homes in poorer neighborhoods after foreclosing on the mortgages.

Some of the changes in the loan sale program were put together after meetings in the winter and spring with housing advocates.

We listened and tried to be responsive, Golding said. I think we did good work.

He noted that a year ago, HUD said private buyers could not complete a foreclose on a mortgage for at least 12 months after acquiring the loan.

Critical report

One organization that participated in those recent talks with HUD officials, the Center for American Progress, released a report on Tuesday that concluded that federal officials had made a mistake in assuming that economic incentives alone were enough to encourage private buyers of mortgages to modify as many loans as possible.

The group’s report said that for private investors, the primary goal is often to deliver to investors the highest profit as quickly as possible. And the report from the center, a politically left-leaning organization, said the government needed to impose more stringent requirements on buyers to get the result it wanted.

It is risky public policy to rely too heavily on assumptions about market forces to protect homeowners, the center said.

Sarah Edelman, the center’s director of housing policy and one of the report’s authors, said the changes announced by HUD were significant improvements in the loan sale program.

The policies announced today are a promising step toward more responsible loan auctions, she said.

It is hard to ignore the political overtones of the changes being announced by HUD, given that Julián Castro, the HUD secretary, is thought to be a potential vice-presidential running mate for Hillary Clinton, who is seeking the Democratic presidential nomination.

In recent months, several liberal activist groups staged rallies, calling on HUD to move more quickly to enact changes to the loan sale program. A number of them started a website and petition drive to put pressure on Castro.

The changes to the program were announced in a news release by Golding, who oversees the FHA, and not Castro.