Tuesday, April 28, 2009

More Details on Making Home Affordable Second Lien Program

by Calculated Risk on 4/28/2009 01:21:00 PM

Press Release from the U.S. Treasury: Obama Administration Announces New Details on Making Home Affordable Program

Under the Second Lien Program, when a Home Affordable Modification is initiated on a first lien, servicers participating in the Second Lien Program will automatically reduce payments on the associated second lien according to a pre-set protocol. Alternatively, servicers will have the option to extinguish the second lien in return for a lump sum payment under a pre-set formula determined by Treasury, allowing servicers to target principal extinguishment to the borrowers where extinguishment is most appropriate.
Here is the program update.

And a couple of examples of how the 2nd lien program would work.

Here are the basics (the interest rate reduction is for 5 years):
For amortizing loans (loans with monthly payments of interest and principal), we will share the cost of reducing the interest rate on the second mortgage to 1 percent. Participating servicers will be required to follow these steps to modify amortizing second liens:
  • Reduce the interest rate to 1 percent;

  • Extend the term of the modified second mortgage to match the term of the modified first mortgage, by amortizing the unpaid principal balance of the second lien over a term that matches the term of the modified first mortgage;

  • Forbear principal in the same proportion as any principal forbearance on the first lien, with the option of extinguishing principal under the Extinguishment Schedule;

  • After five years, the interest rate on the second lien will step up to the then current interest rate on the modified first mortgage, subject to the Interest Rate Cap on the first lien, set equal to the Freddie Mac Survey Rate;

  • The second mortgage will re-amortize over the remaining term at the higher interest rate(s); and

  • Investors will receive an incentive payment from Treasury equal to half of the difference between (i) the interest rate on the first lien as modified and (ii) 1 percent, subject to a floor.
  • The interest only second lien structure is similar with the interest rate being reduced to 2%.

    Although this is a serious reduction in the interest rate, this will probably attractive to 2nd lien investors - since the loss severity on second liens is so high. What happens in five years when the rates change for all these borrowers with negative equity?