There is a new pilot program Wachovia recently put into place intended to rid themselves of that nasty $122 billion Pay Option ARM portfolio while keeping borrowers in their home. While this program definitely has its flaws because it does not come close to addressing the real problem (HOUSE PRICES ARE STILL SIGNIFICANTLY OVERVALUED) it is the closest I have seen yet.
Wachovia’s New Program – ‘The Spend’
First, Wachovia selected a certain number of Pay Option borrowers based upon internal modeling. Each borrower was assigned to a participating mortgage banker/broker and given what they call ‘The Spend’. The Spend is how much money that will be used to modify and refinance the borrower into a new 30-year fixed loan, primarily FHA.
A portion of The Spend is used to buy down a 30-year fixed rate to a level at which the borrower can afford according to present day underwriting guidelines. A portion is also used to reduce the principal balance. From what I am hearing from early cases, the interest rate level on some first mortgages has been as low as 2%. That’s pretty sad when it takes 2% to get borrowers to qualify for a fixed coming out of an Option ARM and just goes to show how leveraged up the borrowers still are. However, The Spend is not forgiveness of debt. It is put into the form of a silent second for a specified term and at an interest rate as low as zero that has to be repaid at some time in the future.
The benefits to Wachovia are obvious. They get rid of these toxic assets sitting on their balance sheet; they get rid of predatory lending liability through the refinance, as the borrower must sign away all rights to future claims; they outsource the loan origination staff expense to other firms; and they get to bring back a portion of the loan loss reserves set aside on each loan refinanced IF The Spend is less than the amount reserved.
If banks are going to start trying to get ahead of the game with proactive loan modifications/refinances, Pay Options are a great place to start. This is because they are truly toxic for the borrower and bank going forward. Currently, Pay Option ARMs are being valued by the market as poorly as straight Subprime despite default rates being nowhere close…yet. This is because over time, most Pay Option borrowers will default due to the way the loan is structured and massive payment recast that occurs. Because Pay Option ARMs allow ultra-low teaser rates for up to 10-years at Wachovia , their Pay Option implosion could have been spread out over several years. But, the market was smart with respect to this loan type realizing that despite the ‘high credit scores’ and ‘lower effective original loan to value ratios’ that they like to brag about, these are essentially all Subprime loans.
But unlike other program types awaiting implosion such as Jumbo Prime ARMs that are still rated and valued as ‘Prime’, Pay Options have been written down to some degree by banks already. This makes throwing money at them more palatable by the bank because if it cost less to make them ‘right’ than the value at which they are currently written down, it can lead to a write-up. Since Pay Option borrowers by and large are of decent quality and if they catch these before they go into default, refinancing them into a new fully documented loan should not be a problem. This may not be the case when dealing with Subprime borrowers, borrowers who are currently delinquent or low documentation borrowers.
There are significant problems with The Spend, however. Most obviously, they are artificially supporting house prices by giving borrowers extremely low interest rates such as a 2% 30-year fixed and a zero interest rate second. In addition, what if values are not at the bottom? The ‘negative equity effect’ is real and if values continue to tumble what’s to say that the borrower will not just walk at a later date. A good number of these may even turn into rentals because with a 2% fixed and zero% second, the property may cash flow.
The thought process is that if the borrower can afford their payments, especially on a 30-year fixed, it does not matter what the value of the home does – they will stay and make their payments. Well, this has obviously been proven wrong, as we are seeing Prime and Jumbo Prime default in greater numbers as values fall. On the other hand with house prices down so far in the areas in which this program is going into effect, there is a much better chance that this fundamental will play out going forward.
But then there is still the silent second hanging over their head and the fact that home owner is underwater by that large of an amount. This makes borrower repayment patterns totally unpredictable across all paper grades. This also makes typically life circumstances such as job loss or illness almost a guaranteed default. If you have equity in your property, you have wiggle room.
One thing is for sure, The Spend is worlds better that the recent BofA/Countrywide settlement scam, in which the AG sold hundreds of thousands of borrowers down the river at a ridiculously low price. Remember gang, once you do something with respect to a mortgage modification or refinance, you lose your rights to come after the lender for predatory lending violations and forced rescission/modification.
The ‘relief’ the borrowers will get from BofA will be of the kind I mentioned in a recent post, ‘Countrywide/BofA – A Direct Threat to Borrowers’, where Countrywide gave a borrower a $900k five year 2% interest only loan on a $500k home essentially pushing the problem out five years and ensuring a foreclosure at that time.
That is why it is so important to do it right with permanent principal balance reductions if you are going to do it at all. I talk about this in my new video, ‘Mr Mortgage – Time To Get Your Bailout‘.
At my independent research firm, Field Check Group Real Estate & Finance, I can watch in real-time each and every loan default from all lenders so I will keep an eye out on how this program is working and how Wachovia’s portfolio is performing and periodically let you know. If you get a call in the meantime by a Wachovia partner offering you something that is too good to be true, think very carefully because it just may be. -Best Mr Mortgage