With unemployment very high, income loss is now the primary reason for mortgage default. Unemployed homeowners face tough choices. Those with equity in their house may attempt to sell it quickly. Alternatively, to keep their house while seeking a new job, they might deplete their savings, apply for a loan modification, or use other credit. Those with negative equity—who owe more on the mortgage than the property’s current value—have fewer choices, because selling the house won’t pay off the mortgage. All too often the home enters foreclosure and becomes costly for the family and the community. In this post, we examine how states may be able to offer special bridge loans to help jobless homeowners pay their mortgages and help protect neighborhoods and housing markets. Such initiatives could complement existing programs by helping many distressed homeowners before they miss any payments.
When Loan Modification Programs May Not Be Suitable
Many efforts to address the housing crisis thus far have focused on modifying mortgages to make them more affordable permanently or for a set period of time. When a jobless homeowner’s income loss is likely to be in large part permanent and/or the loan was unaffordable even prior to the income loss, the efficient economic outcome may require a loan modification. Even so, obtaining a modification can be an uncertain, complex, and lengthy process. And many jobless homeowners don’t qualify.
When the income loss is likely to be temporary and the loan is otherwise sustainable, a better strategy may be to leave the mortgage as is and have the government provide a bridge loan to the borrower to cover part of the mortgage payment until the borrower is reemployed. This form of assistance is embodied in the Department of Housing and Urban Development’s recent Emergency Homeowners’ Loan Program (EHLP). However, EHLP offers only one-time funding for currently unemployed borrowers, and all applications were due by July 22, 2011.
An alternative approach to a loan modification that provides ongoing assistance would be similar to a Pennsylvania initiative undertaken more than twenty-five years ago to aid borrowers who become delinquent due to a loss of income.
The Pennsylvania program is called the Homeowners’ Emergency Mortgage Assistance Program, or HEMAP. (Our recent New York Fed paper describes how the program works, its costs, and its impact.) We focus on this program because it has an established track record: Roughly 80 percent of participants have remained in their homes and repaid their loans in full. While lending to unemployed borrowers is generally risky, HEMAP’s experience suggests that lending by the government to a carefully screened group of unemployed borrowers can be a successful strategy to help distressed homeowners.
Designing an Assistance Program for Unemployed Borrowers
States could provide assistance to unemployed homeowners by implementing a variation of HEMAP. They could do so in a way that leverages existing resources to get such a program up and running quickly. While the Pennsylvania program covers a range of reasons for an income loss, as does the EHLP, there are benefits to tailoring the assistance specifically to homeowners who have suffered a job loss. Importantly, the application process could begin when the individual files for state unemployment insurance (UI). This takes advantage of the resource networks that states already have in place to administer their UI programs. In addition, starting the application process before the homeowner is delinquent on the mortgage avoids the use of loan proceeds to cover late fees and arrearages. The experience in Pennsylvania has been that unemployment is the key driver of applications to HEMAP, so an unemployment-based program addresses the key area of concern.
Based on Pennsylvania’s experience, there are four essential criteria for screening an application for approval:
- the homeowner became unemployed through no fault of his own,
- the homeowner was able to afford the mortgage payments prior to the job loss,
- the homeowner has equity in the house that can serve as collateral for the bridge loan, and
- the homeowner has a reasonable prospect of reemployment at an income close to that of the prior job.
The first criterion also pertains to people applying for UI. The second can be ascertained by looking at the homeowner’s mortgage payment history for the twelve months prior to the job loss. This requires that the homeowner agree to allow the state to contact the credit bureaus. The third criterion can be determined by comparing the current loan balance (from the most recent mortgage billing statement) with an estimate of the property value. As part of the application, the homeowner could be required to supply a copy of the most recent mortgage billing statement. This indicates the current balance on the mortgage as well as the name of the servicer. The presence of any second liens on the property can be ascertained from the credit report. Appraisals could be used to determine the current property value for each application. Alternatively, to conserve on appraisal fees, the state could use an automated valuation method (AVM) to generate an estimate of the homeowner’s percent equity, and follow up with an appraisal only when the AVM indicates a low or negative equity position.
An important aspect of HEMAP’s screening process is evaluating the homeowner with respect to the last criterion—the reemployment prospect. In Pennsylvania, this is done on an individualized basis. States creating new programs could adopt such a process. Alternatively, they could sacrifice some precision for efficiency and base their analysis on the earnings qualifications they already impose for their UI program. While not a perfect substitute for an individualized review, this UI earnings test would help to identify homeowners who have better reemployment prospects. The advantage again would be to leverage existing resources.
In today’s housing market, perhaps the central challenge is how to assist a negative equity homeowner who qualifies for a bridge loan. In this situation, the state would essentially be making an unsecured loan. The program design would have to balance the expected benefits to the homeowner, and the wider community, of providing assistance against the expected costs to taxpayers from default on the loan. One option would be for the state to notify the servicer representing the lenders that the borrower has been approved for a bridge loan conditional on the servicer writing down the balance outstanding to a stipulated percentage of the current property value. Because a borrower who has lost his or her job and has negative equity is a high default risk, and foreclosed homes typically sell at a significant discount, the servicer would have a strong incentive to agree.
States could make their bridge loans conditional on some concession by the lenders, such as a temporary reduction in monthly payments. But there would be a trade-off here, because making the bridge loan conditional on lender concessions—which HEMAP doesn’t do—would likely slow adoption of the program as well as lengthen the loan approval process. A better approach might be to require broader concessions by large lenders—for instance, on servicing standards—as part of a package deal involving the creation of bridge loan programs, rather than to seek concessions on a loan-by-loan basis.
Lending to a carefully screened group of unemployed borrowers could be a successful strategy for states to assist distressed homeowners, reduce economically inefficient foreclosures, and help stabilize house prices for the benefit of the public at large. This approach avoids the complexity of working with servicers to change mortgage terms. Where modifications are required as well, the prospect of a bridge loan could provide an incentive for servicers to act.
While there are many advantages to establishing these loan programs at the state level, a key issue is how to fund the programs during periods of tight state budgets. For example, as of July 2011, HEMAP stopped making new loans because of reduced state funding. Instead, applicants were reviewed for an EHLP loan while that program was in effect. Continuity of program funding could be achieved by allowing states to borrow from the federal government to cover funding gaps during periods when state fiscal constraints are binding.
The logic here is simple: If the problem is the mortgage, fix the mortgage; but if the problem is temporary unemployment, fix the cash flow. Of course, if the problem is both, then tackle each in a coordinated manner. The Pennsylvania program provides heartening evidence that it’s possible to fix the cash flow problem at a moderate cost.
The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).