Major Mortgage Lender Begins Selling Loans in Default

The Federal Housing Administration (FHA) recently developed a program to help homeowners facing possible foreclosure and to prevent an excess of defaulted mortgages and home loans. The new program, known as the Distressed Asset Stabilization Program, is an extension of the FHA pilot program that currently gives investors the opportunity to purchase loan pools on their way to foreclosure.

As of March, 2012, the FHA had more than 700,000 loans in default, which made up more than 9 percent of the $1 trillion in home loans it insures. Bulk loan sales are anticipated to give the FHA an opportunity to unload defaulted loans and the costs associated with foreclosure.

How the Program Works

This month marked the beginning of the program when the FHA opened up bids for the sale of 5,000 nonperforming formerly insured agency loans. In April, the agency sold 279 loans to buyers for nearly $19 million, which represented about a third of the loans’ outstanding balances. Last year, the agency sold close to 2,200 loans through the pilot program.

The FHA said it will begin selling about 5,000 defaulted loans every quarter as it expands the pilot program that began last year. The agency, which has 35,000 repossessed properties on its books, is eager to sell the loans at a discount in an effort to prevent the homes from going into foreclosure.

A loan can enter the pool only if it meets preset criteria. For example, the loan must have been delinquent for at least six months but it can’t be involved in bankruptcy; the FHA’s loss mitigation steps must be completed; and the loan cannot be in foreclosure proceedings.

Loans in the pool are typically sold below the outstanding principal balance. Acting FHA Commissioner Carol Galante said the government mortgage insurer plans to continue large note sales which require investors to refrain from foreclosure for six months. Distressed note sales save the cost of maintaining the note throughout the foreclosure process. An estimated 30 percent of all foreclosed properties currently on the market are owned by FHA or another government-controlled finance company such as Fannie Mae or Freddie Mac.

The FHA is a branch of the U.S. Department of Housing and Urban Development and has insured more than 34 million mortgages since its inception in 1934. It is financially supported by the mortgage insurance premiums it charges to borrowers.

The Process

As a part of the FHA program, buyers must first attempt to work with the borrower to make the loan current and avoid default. It is anticipated since the notes are sold at such a significant discount that the buyer will take advantage of a principal reduction modification and refinance the property to the existing borrower at a profit.

If they are unable to prevent foreclosure, investors are restricted from selling more than 50 percent of the properties in their pools. In addition, if neither the servicer nor the borrower can bring the loan out of default, the servicer is required to keep it for at least three years. This is to prevent a quick flip of the home while creating a more stabilized situation.

The concept of selling delinquent loans before they reach foreclosure also may allow investors to convert some properties into rental housing, which will keep the properties occupied.

Program Benefits

Economists say selling the loans benefits both the FHA and the mortgage lien holder on the verge of foreclosure.

By selling the loan, the FHA has the opportunity to recoup some money, as a foreclosed property typically costs the agency close to $30 a day to maintain and market. The agency also loses nearly 64 cents on every $1 on foreclosed mortgages. If the defaulted loan can be sold at a similar reduction, it prevents further losses.

Selling the loan to an investor stops the foreclosure process which will benefit both the homeowner as well as the volatile real estate market.

A specific neighborhood stabilization pool will be created to support investment in certain communities hard hit by the foreclosure crisis. Eight communities have already been selected but plans have not been released to the public yet. It is believed Chicago is a potential candidate.

Secretary of Housing and Urban Development (HUD) Shaun Donovan said he hopes the new program will give homeowners a new set of options and renewed hope.