The Home Affordable Modification Program (HAMP) was a necessary lifeline to people who were in danger of foreclosure during the housing crisis of the late 2000s. It was created by the Financial Stability Act in 2009 to provide incentives to lenders for refinancing instead of foreclosing, and has been used to modify the loans of around 1.1 million people.
However, the rate reductions were set to last only five years, on the assumption that the housing market and overall economy would improve by that time. It has, in some areas – but there are a number of people that may be put back into risk of default by the rising rates.
HAMP rules direct lenders to take steps to reduce the debt-to-income ratio (DTI) to 31%, the standard for a lower-risk mortgage. This is accomplished through a "waterfall" process as shown below:
- Capitalization – The outstanding loan amount and all delinquent payments are added up to create a new loan balance.
- Reduce Interest Rate – The interest rate is temporarily dropped to produce a DTI of 31%, but cannot go below 2%.
- Extend the Term – If the interest rate drop alone cannot achieve 31% DTI, the loan term will be extended until the DTI goal is reached – but not beyond 40 years.
- Principal Forbearance – If interest rates and term extensions still can't get you to 31% DTI, a non-interest bearing, non-amortizing balloon payment will account for the difference.
The 2010 Principal Reduction Act applies the same rules, except it starts with a principal reduction step after capitalization. For underwater homeowners with high LTV (loan-to-value) ratios, the lender reduces unpaid balances to achieve 31% DTI, but not below an LTV of 115%. At that point, the remaining waterfall steps take place (interest rate reduction, etc.).
Similar programs were initiated by individual lenders to avoid defaults. The Urban Institute estimates that almost five times the number of people have these proprietary modifications – if correct, that means over 6 million people were granted temporary relief with their payments and interest rates.
Did we say temporary? Yes, indeed. The rates were locked for five years, and then will adjust 1% per year until they reach the mark that they were at when the relief was granted and the modified loan took effect. For the first participants in 2009, that rise starts this year.
If you are currently in a HAMP or proprietary modified loan, you should check the details of your loan now and, keep a close eye on the housing market, interest rates, and the value of your house over the next few years. You will be searching for the best possible opportunity to refinance.
Well before the yearly increase takes effect (perhaps six months), check your refinancing options. Your best hope is for a significant rise in the value of your home without a corresponding rise in interest rates. That is a delicate balance, and you probably have a limited window for this to occur.
Plot out the effect of your increased interest rate payments for reference – if you need help, online calculators are available. Meanwhile, make sure you keep bills current and your credit report clean, and gather all the financial information you need (statements, tax returns, account balances, etc.) to explore refinancing options. That way you can act quickly on any good refinancing opportunities.
The Urban Institute's report suggests the real crunch will not occur until 2016-2017, when the first few years of recipients will be undergoing their third rate adjustment. If defaults are increasing and the housing market begins to tank again, expect some form of relief to continue – especially in an election year.
Keep an eye out for a possible HAMP extension, or the introduction of any new relief program – and don't forget to work with your lender. They have already decided it is in their best interests to keep you as a customer rather than foreclose on you.
Hope for better times, but don't count on them – and be ready to refinance quickly when a good deal becomes available.