Quote:

The current problem in subprime mortgage lending arose with the rapid growth of 2- and 3-year adjustable rate subprime hybrid loans after 2003. Between year-end 2003 and mid-2007, some 5 million of these loans were originated. Of these, slightly over 2.5 million loans with outstanding balances of $526 billion remain outstanding.

The typical structure of these loans is to provide for a starter rate (typically between 7 and 9 percent), followed in 24 or 36 months by a series of steep increases in the interest rate (often totaling 5 percent or more) and a commensurate rise in the monthly payment. Almost three quarters of subprime mortgages securitized in 2004 and 2005 were structured in this manner, as were over half the subprime loans made in 2006. Most of these loans also imposed a prepayment penalty if the loan was repaid while the starter rate was still in effect.
...
It appears that subprime loan portfolios can be split into three basic groups: the small subset of loans that can be expected to perform after reset without modification, loans that became past due under the starter rate and probably cannot repay even if they are modified, and loans that have remained current prior to reset, but will likely not remain so after reset without modification.

... For loans that remain current or less than 60 days delinquent, only 3.3 percent show both a loan-to-value ratio below 80 percent at origination and a debt service-to-income ratio below 30 percent -- attributes that might indicate a high probability of remaining current even after reset. ....

With regard to that small subset of borrowers who have the ability to repay without modification, these loans should continue according to their contractual terms. As for loans that are already past due and cannot reasonably be expected to repay, even with restructuring, there may be no alternative except for foreclosure. The same is true for loans that were made under fraudulent circumstances or to speculators.

A key issue is how to address the mortgage loans for owner occupied properties where the borrowers are current on their payments but will not be able to maintain the payments following reset. If servicers do nothing and allow all of these loans to reset to the full contract rate, the result will be the eventual default and foreclosure on hundreds of thousands of additional loans.

For this group of borrowers, Chairman Bair has recommended that servicers take a systematic and streamlined approach to restructuring these loans into fixed rate loans at the starter rate -- which is already above market rates for prime loans. These loans should be evaluated to determine the borrowers' ability to make the payment following reset and the net present value (NPV) of the loan modification should exceed the NPV of allowing the loan to go into foreclosure. Loans that are current after two years have clearly demonstrated a record by the borrower of a consistent willingness and ability to repay at the starter rate, which bodes well for their ability to repay at that rate over the long run.
...
Correcting Misconceptions about Mortgage Restructuring

Let me turn now to a number of misconceptions about the impact of Chairman Bair's loan modification proposal and explain how the proposal would work.

Misconception: Restructuring Will Create a Windfall for Subprime Borrowers

Some have expressed concern that restructuring subprime loans to a fixed rate of interest at the starter rate will result in a windfall for subprime borrowers. This misconception is based on the belief that the starter rates for these loans are similar to the low 1 to 2 percent "teaser" rates that were aggressively advertised for prime borrowers. In fact, of subprime hybrid mortgages originated in the first quarter of 2006, the average starter rate was 8.28 percent, which exceeded the average rate on subprime fixed rate loans made in that same quarter (7.93 percent), and was well above rates paid on prime fixed rate loans. These subprime borrowers will continue to pay higher subprime rates even after restructuring.

Misconception: Restructuring Will Deny Investors Their Expected Return

Another popular misconception is that restructuring will deny investors a large stream of interest payments that would rightfully accrue to them after the loans reset to the full contract rate. The reality is that very few hybrid borrowers actually remain in the pools after reset and pay the full contract rate. Among such loans made and securitized in 2003, only one in 30 continues to pay at the full contract rate after four years.

Last modified: 2007-12-02 13:50:57 by al_tannr
Reason: Fix URL & grammar