Congress is pressuring the mortgage industry to hold off on foreclosures pending the startup of the FHA “Hope for Homeowners” refinance program established by the Housing and Economic Recovery Act. (Actually, both House Financial Services Committee Chairman Barney Frank (D-Mass.) and Senate Banking Committee Chairman Chris Dodd (D-Conn.) began pressuring mortgage servicers even before President Bush signed the bill into law on July 30.)

The housing bill’s rescue provisions will refinance qualified individuals through the FHA program starting October 1 — a delayed effective date that coincides with the start of the federal government’s fiscal year. The Congressional Budget Office estimates that the program could help at least 400,000 borrowers who have fallen behind in their payments.

On August 5, Frank and three other members of his committee strongly urged the mortgage industry to hold off on foreclosures for potentially qualified homeowners for the next several months while a new FHA rescue program gets under way.

“Many mortgage servicers and others in the servicing industry have told us about the progress they are making (and expect to make) to address the foreclosure crisis through, among other things, a greater willingness to engage in meaningful loan modifications that materially alter a borrower’s ability to repay the loan and new hiring of servicing professionals to more quickly address the backlog,” Frank said.

“Unfortunately, individuals facing foreclosure, consumer advocates and others have painted a very different picture: one that involves long waits and few, if any, meaningful loan modifications,” Frank added.

Sticking Points

Frank’s letter also highlighted two sticking points in the foreclosure avoidance process — principal reductions and previous loan modifications..

1. Principal reductions: Frank asked servicers whether they anticipate making the principal reductions necessary to qualify for refinancing at-risk borrowers into the Hope for Homeowners Program. The letter noted that a while a number of servicers have generally avoided significant principal write-downs to date, they must accept substantially increased write-downs to take advantage of the Hope for Homeowners Program.

As the letter explained, “The general view has been that principal write downs have been a ‘last option’ for servicers because they represent an immediate loss for investors but (even if meaningful) leave investors and servicers with ongoing credit risk. Given falling housing prices, servicers and investors have heretofore preferred to take their losses now — foreclosing on the property — rather than a principal loss now and potentially greater loss later [if the borrower defaults a second time]. This, of course, facilitates more foreclosures, puts more houses on the market, and risks a vicious cycle.”

Frank told the industry that the Hope for Homeowners Program eliminates this problem “by permitting servicers and investors to take a single large loss now (through a principal reduction) — but eliminates the risk of future loss.”

2. Previous loan modifications: Frank also asked servicers if their servicing practices provide that a previous loan modification would disqualify a borrower from the principal modifications required by the Hope Program.

Servicers have told the committee a previous loan modification would not disqualify a borrower from the principal reductions required to participate in the Hope Program. However, a number of housing counselors have said that some borrowers are not currently receiving a second modification even if the first modification was clearly too small to meaningfully affect their ability to repay the loan.

To make sure the industry is paying attention to these concerns, the Financial Services Committee will hold a follow-up hearing on servicing practices on September 17. Chairman Frank had previously warned that, if the mortgage-servicing industry tells him it can’t grant forbearance because lenders and servicers are different organizations, then he might have to back legislation to restructure the mortgage servicing industry to negate that problem.