In Depth Analysis: CalculatedRisk Newsletter on Real Estate (Ad Free) Read it here.

Sunday, July 03, 2011

NY Times: Principal Reductions for some Option ARMs

by Calculated Risk on 7/03/2011 09:14:00 AM

From David Streitfeld at the NY Times: Big Banks Easing Terms on Loans Deemed as Risks

Two of the nation’s biggest lenders, JPMorgan Chase and Bank of America, are quietly modifying loans for tens of thousands of borrowers who have not asked for help but whom the banks deem to be at special risk.

Rula Giosmas is one of the beneficiaries. Last year she received a letter from Chase saying it was cutting in half the amount she owed on her condominium.
Banks are proactively overhauling loans for borrowers like Ms. Giosmas who have so-called pay option adjustable rate mortgages ...

Ms. Giosmas bought her two-bedroom, two-bath apartment north of downtown Miami for $359,000 in early 2006, according to real estate records. She made a large down payment, but because each month she paid less than was necessary to pay off the loan, her debt swelled to about $300,000.

Meanwhile, the value of the apartment nosedived. By the time Ms. Giosmas got the letter from Chase, the condominium was worth less than half what she paid. “I would not have defaulted,” she said. “But they don’t know that.”

The letter, which Ms. Giosmas remembers as brief and “totally vague,” said Chase was cutting her principal by $150,000 while raising her interest rate to about 5 percent.
These principal reduction programs are not new. Here was a story about a Wells Fargo program last year:
Wells Fargo has forgiven an average of $46,000 in principal, or 15 percent, for the 43,500 option-ARM loans it has modified this year through September, said Franklin Codel, chief financial officer at the bank’s home-lending unit. The San Francisco-based lender has cut as much as 30 percent off the loan principal in a few “rare exceptions,” with the ceiling typically capped at 20 percent, Codel said.
The banks have kept these programs somewhat quiet - imagine what would happen to Chase or Wells Fargo if their borrowers found out that the banks would substantially reduce their principal if they were 1) underwater (negative equity), and 2) stopped making their payments? The delinquency rate would increase sharply.

Instead the banks quietly approach "high risk" borrowers with substantial negative equity - and who are current on their loans. These are usually borrowers with option ARMs, who made substantial downpayments, and who have solid credit ratings. Although the banks can't be sure who will default, their models suggest these modifications will lead to lower losses.

Also these banks (like Chase and Wells) took substantial write-downs when they inherited these loans, from WaMu and Wachovia respectively, so they can reduce principal on selected loans without incurring further losses.