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Fending off foreclosure: lenders and investors are perfecting ways to throw lifelines to borrowers whose loans are heading for trouble.


Fannie Mae, a long-time leader in the default mitigation field, plans to push lenders harder this fall to find alternatives to costly foreclosures.

At the same time, Freddie Mac is said to be at work on a pre-foreclosure sale program similar to Fannie Mae's. And the Federal Housing Administration (FHA) is expected to start a foreclosure alternatives program by the end of the year.

As foreclosure costs continue to rise, it's no surprise to see major mortgage investors such as Fannie Mae, Freddie Mac and mortgage insurers such as HUD, improving and refining their foreclosure prevention efforts.

Lenders benefit from the absolute dollars saved when a default is cured and a delinquent loan returns to the regular servicing portfolio. And the more delinquencies a lender cures, the fewer employees needed to handle foreclosures.

Taking the lead over the past three years, Fannie Mae modified 14,000 loans and assisted with pre-foreclosure sales on another 3,000 loans to prevent them from moving into the costly foreclosure arena. The corporation would like to see more of the same in the years to come.

"In the 1990s, these are the programs we want our lenders to pursue. There's got to be an alternative to foreclosure," says Tom Ducey, Fannie Mae's director of loan servicing and lender standards.

Freddie Mae also appears to be joining the foreclosure prevention club. The corporation is now actively working on a pre-sale program of its own, sources say.

FHA, too, is working on a pre-sale program, an option now open to them thanks to legislation passed in 1988. However, the agency may require lenders to review the pre-sale potential of every loan and to rely on third parties to negotiate the pre-sales. That worries some lenders.

"My concern is that they will develop something so cumbersome that it won't be useful... that it will be difficult for us to work with," says one source familiar with the program.

Relaxing the rules

For lenders, mortgage insurers and investors, many of today's default mitigation lessons were learned during the record high foreclosures of the mid-1980s. Faced with thousands of REOs and whole neighborhoods up for sale, lenders wanted to avoid adding to their inventories of foreclosures. But too often, agency guidelines worked against that goal.

For instance, when the oil patch states went bust back in 1986, Fannie Mae policy prohibited adjusting interest rates or payments to modify loans in default, explains Ducey.

At that time, homeowners with rising, unpaid principal balances due to negatively amortizing loans - a feature they may or may not have understood - watched while their property values dropped. Thousands of these loans fell into default.

In response, Fannie Mae began a pilot default mitigation program. Looking for delinquent borrowers who wanted to stay in their homes and could afford to do so, the corporation began modifying loans to prevent foreclosures in oil patch states.

In 1988, Fannie Mae took the program one step further. Instead of waiting for a borrower to default, Fannie Mae combed its portfolio to weed out defaults before they happened.

Fannie Mae searched among its loans in distressed economies for mortgages with two of three characteristics: high interest rates; prior delinquencies and negative amortization.

Then it began modifying the loans; shifting borrowers into more affordable, fixing-rate mortgages.

Fannie Mae also reconsidered its guide provisions for another option available to lenders working with seriously delinquent borrowers: pre-foreclosure sales.

Ducey sums up Fannie Mae's thinking on pre-foreclosure sales this way: "If [a] house was going to have to be sold, why not sell it before it went to foreclosure?"

Neither of these options are a "give-away," he says. "Often we would ask the borrower to contribute cash to help mitigate the loss."

Fannie Mae contributes too, paying lenders a fee to solicit borrowers about loan modifications and pre-foreclosure sales.

To help lenders improve their default mitigation skills, the corporation offers seminars and a series of reference books called Controlling Default. Together, the seminars and books educate lenders on managing delinquencies and help them identify high-risk loans.

Pushing ahead

The goal of Fannie Mae's foreclosure mitigation program is shared by many lenders: to help deserving borrowers who are facing hardship, without letting

financially capable borrowers walk away unscathed.

This fall, to corner those able, but unwilling borrowers, Fannie Mae plans to increase its demands that lenders pursue deficiency judgments against walkaway borrowers.

"We're not advocating that in every case you go for a deficiency judgment, but we don't want people who think it's just inconvenient to continuing paying the mortgage to walk away," Ducey says.

FHA's deficiency judgment program has worked so well that a growing number of borrowers are approaching FHA field offices with compromise offers before a deficiency judgment is obtained.

FHA recently got serious about deficiency judgments after an article appeared in the New York Times describing the apparent ease with which a walkaway borrower had abandoned a Colorado condo.

According to a confidential HUD memorandum, the agency's headquarters has responded to borrowers looking for compromises by giving its field offices full discretion to accept settlements of potential deficiency judgment claims of less than $30,000. Potential compromises on claims for higher amounts will still have to go through headquarters.

In addition to deficiency judgments, Fannie Mae also plans to get more aggressive in the area of bankruptcy monitoring.

Too often, Ducey says, lenders don't monitor bankruptcies closely enough. For instance, he explains, in Chapter 7 bankruptcies, the automatic stay protecting the borrower's assets usually gets lifted temporarily, giving lenders a chance to proceed with a foreclosure. Sometimes lenders don't proceed and miss the opportunity, he says.

Fannie Mae plans to use accounting system enhancements to capture more data on bankruptcies. Then, the corporation will try to locate lenders with high numbers of bankruptcies, targeting them for additional assistance and review, Ducey says.

Finally, Fannie Mae plans to ask lenders to more aggressively pursue assignment of rents from two-to four-family properties with delinquent mortgages. "We don't want the investor/owner to continue getting that rent," says Ducey.

Consider it help

What Fannie Mae considers assistance and "increased awareness" many lenders might view as extra oversight. But, before writing off foreclosure mitigation as another Washington, D.C.-induced headache, look at the money you might be able to save.

If you are as large as Lomas Mortgage USA, Dallas - and granted most mortgage bankers aren't - default mitigation could save you $4 million over two years.

Lomas' big savings started after the company found a way to beat the GNMA system that prevents most lenders from modifying FHA-insured loans.

Current GNMA rules state that a lender must repurchase any modified loan. Because many mortgage bankers aren't that capital rich, repurchasing modified loans is a tall order and not that practical. Furthermore, after the modifications, a mortgage banker would need to resell the loans.

Through the Lomas program, called Operation Opportunity - "Op-Op" for short - Lomas pulls loans from its Ginnie Mae pools and restructures them. But after modifying the loans, Lomas repackages and sells them in the secondary market to recapture the capital it put up to repurchase the loans.

Op-Op also offers borrowers a second option - short sales, also called compromise sales.

The trick in the Lomas program is finding a secondary market investor willing to take the restructured loans. Although Lomas is reticent, for obvious reasons, to share the identity of its lone investor in modified FHA loans, it did agree to share data from its modification program.

Of 1,200 modifications during the past two years, "89 percent of what we attacked has survived," says Lomas Senior Vice President Terry Deyoe. There is a cumulative, rather than annual, default rate of only 11 percent among the loans in the program.

That compares favorably to the VA's own supplemental servicing efforts. Annually, 76 percent of VA home loans that are 90 days or more delinquent are cured before they go to foreclosure, reports VA Director of Loan Guaranty Keith Pedigo. "Most of those are self-cures where the veteran clears up the delinquency," he adds.

Although Op-Op creator and Lomas Senior Vice President Bill Rudliff admits not everyone could spend $200,000 and save $4 million as his firm did, he does believe smaller lenders can save a proportionate amount. "The savings would certainly cover the cost of the program," he believes.

Lomas also actively solicits refinancing of its high-interest-rate loans, concentrating on loans 60 days or more delinquent.

Unlike Fannie Mae, Lomas doesn't look for any characteristic other than a high interest rate when it combs its portfolio for potential modification candidates.

MI's involvement

Mortgage insurers, too, are more readily accepting workouts and pre-foreclosure sales. Mortgage Guaranty Insurance Company (MGIC) Senior Vice President for Claims Lou Zellner says her firm has modified 11,000 loans worth $800 million in recent years.

MGIC's modification program has worked well on some, but not all, loans. "If there was an investor in the loan, but not a bond, we were very successful," Zellner says.

Pre-foreclosure sales are the most successful type of default mitigation at MGIC. MGIC also accepts deeds-in-lieu of foreclosure, often getting the borrower to contribute money to help cover any loss.

Over the last few years, Zellner believes - although there's no evidence to prove this - that the number of walkaway borrowers has increased. "It's hard to quantify the increase and it's hard to speculate about why [there are more walkaways]. Maybe it's that people are more mobile than they used to be," she says.

MGIC also considers options other than loan modification, including extending second loans - something it wouldn't consider as recently as five years ago.

All the way

Just how far can a servicer go with a foreclosure mitigation program? Banc-Boston Mortgage Corporation, Jacksonville, Florida, manages to derail an amazing 36 percent of its loans headed for foreclosure.

And when you're servicing a $20 billion portfolio of 350,000 loans that's a lot of pre-sales, forbearance, recasting, modification, deeds-in-lieu, assigments and pre-claim advances.

"We have learned that a pre-sale is better than a no-sale," says Banc-Boston Senior Vice President and Director of Default and Liquidation Administration Gayle G. Edwards.

The mortgage bank's attitude about foreclosures is an outgrowth of its number one priority: excellent customer service. "That includes every customer, even the defaulted customer," explains Edwards.

BancBoston has a very active foreclosure review committee that, along with collectors, looks for potential workouts to refer to a sales and modification department. "Every loan is specifically reviewed to see if there is any alternative to foreclosure," she says.

While foreclosure alternatives may not have filtered down to that many mortgage banking operations, clearly they are the wave of the future. In other words, as Edwards puts it: "Loss mitigation has become a necessity rather than a luxury."

Dona DeZube is a freelance financial writer based in Columbia, Maryland.
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Author:DeZube, Dona
Publication:Mortgage Banking
Date:Nov 1, 1990
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