U.S. Department of Housing and Urban Development Providing Alternatives to Mortgage Foreclosure: A Report to Congress March 1996 Acknowledgements This report was written by Charles A. Capone, Jr. with special assistance from Harold L. Bunce, Frederick J. Eggers, and William J. Reeder, Office of Policy Development and Research. Research support was provided by Ferdinand Nwafor and Delores Roddy, and additional contributions were made by the Office of Housing, Office of the General Counsel, and the HUD Library staff. Many other persons and organizations have made contributions to this study, and the Department wishes to thank them for their willingness to devote time and talent to this effort: BancBoston Mortgage Corporation BancPLUS Mortgage Corporation Bank United Carl I. Brown and Company Fannie Mae Freddie Mac General Electric Mortgage Insurance Corporation Kendall Mortgage Corporation La Salle Talman Mortgage Corporation The LOGS Group Lomas Mortgage USA Magnolia Federal Bank for Savings Mellon Mortgage Corporation Meridian Mortgage Mortgage Bankers Association of America Mortgage Guaranty Insurance Corporation Mortgage Insurance Corporation of America National Consumer Law Center Office of the Honorable James P. Moran, U.S. House of Representatives Pennsylvania Housing Finance Agency Professor Robert O. Edmister, University of Mississippi Rio Grande Savings and Loan Association Savings and Community Bankers Association Standard Federal Savings Association United Guaranty Residential Insurance Company U.S. Department of Veterans Affairs, Loan Guaranty Service U.S. General Accounting Office Many organizations not listed here were also contacted in the course of this study. While they were not able to provide direct input, they often provided leads to persons and organizations that could. The Department is indebted to them for their support. i Contents Acknowledgements i List of Figures vi List of Tables vi Executive Summary vii Introduction vii The Problem of Foreclosures vii Managing Delinquencies viii Current Practice in Foreclosure Avoidance ix Federal Guaranty and Insurance Programs xi Foreclosure Law xiii Regulatory and Legislative Recommendations xiv 1. Introduction to the Study 1 1.1 Legislative Mandate 1 1.2 Impetus for the Legislation 2 1.3 Foreclosure 2 1.4 Mortgage Market Organizations 3 1.5 HUD's Approach to This Study 5 1.6 Overview of Report 6 2. Mortgage Delinquency and Foreclosure Magnitudes 7 2.1 Definitions and Dimensions 7 2.2 Becoming Delinquent 9 2.3 Delinquency Monitoring and Intervention 11 2.4 The Magnitude of Foreclosures 13 3. Loss Mitigation and the Decision to Foreclose 19 3.1 History and Development: 1940-1970 19 3.2 History and Development: 1970-1985 21 3.3 History and Development: 1985-present 23 3.4 Loss Mitigation 24 Staying in the Home 26 Forbearance 26 Loan Modifications 27 Other Options 30 ii Contents 3.4 (continued) Relinquishing Rights to the Property 30 Preforeclosure Sales 31 Deeds-in-Lieu 31 3.5 The Foreclosure Decision 32 3.6 The Cost Effectiveness of Workouts 38 3.7 Protecting Borrower Equity 46 4. Insurer and Guarantee Agency Relationships With Loan Servicers 48 4.1 Approaches to Servicer Relations in Loss Mitigation 48 4.2 Innovations 52 Class I 52 Class II 53 Class III 54 Wrap-up 55 4.3 The Servicer Perspective 56 Borrower Responsiveness 57 Insurer and Guarantee Agency Standards 57 Success Rates 58 Current Bottlenecks 59 The Portfolio Perspective 60 Future Options 61 5. Federal Mortgage Insurance Through the Federal Housing Administration and the Department of Veterans Affairs Mortgage Guaranty Service 63 5.1 The Department of Housing and Urban Development, Federal Housing Administration 65 Borrower Foreclosure Relief 65 History of FHA Programs 66 TMAP 68 Disposition of Loans in 90-day Default 71 Assignment 71 How Assignment Works 74 The Dimensions of the Portfolio 79 Current State of HUD Relief Efforts 85 Lender Assisted Refinancings 86 Loan Sales 86 Recasting Refinancings 87 Special Forbearances 87 Preforeclosure Sales 89 Interest Rate Reduction Authority 90 iii Contents 5.1 (continued) Summary of HUD Initiatives 91 Next Steps 93 Additional Tools Still Needed 94 Advance Claims 94 Loan Modifications 94 Managing the Secretary-Held Portfolio 95 Temporary Mortgage Assistance Payments Program 95 Pennsylvania Homeowners' Emergency Mortgage Assistance Program 96 Wrap-up 99 An Additional Concern: Repayment of Forbearances 100 Mortgage Credit Insurance 101 5.2 Department of Veterans Affairs Loan Guaranty Program 102 6. Foreclosure and Bankruptcy Law 107 6.1 State Foreclosure Laws 107 Property Rights Issues 107 History of State Laws 108 Understanding the Foreclosure Process 109 Criticisms of Current Law 110 6.2 The Impact of State-Specific Statutes 116 Industry Practice 116 6.3 Statutory Redemption Periods 118 Use of Statutory Redemptions 118 Benefits to Borrowers 124 Tax Liens 125 6.4 Deficiency Judgements 126 Allocation of Risk 126 Discharge of Indebtedness Taxation 127 6.5 Moratoriums 128 6.6 Bankruptcy 129 Cram downs 132 Fraudulent Transfer in Foreclosure 133 Appendix 6.1: Uniform Land Security Interest Act Part 5: Default 135 7. Regulatory and Legislative Issues and Recommendations 146 7.1 Loan Modifications 146 Recommendations 148 7.2 Foreclosure Law 148 Extending the Equity of Redemption 149 iv Contents 7.2 (continued) Foreclosure Auctions 149 Preforeclosure Settlements 151 Timing of Foreclosure Initiation 151 Homes with High Equity 152 Recommendations 152 7.3 Programs of the Federal Housing Administration 153 Servicer Initiative 153 Workout Departments 154 Payment Assistance 154 Default Counseling 155 Training of Servicer Workout Specialists 155 Recommendations 155 7.4 Other Recommendations 156 Bibliography 157 v Contents List of Figures 2.1 Regional Mortgage Delinquencies 10 2.2 Percent of Single Family Mortgage Loans in Foreclosure Processing 15 2.3 Estimates of Annual Single-Family Mortgage Foreclosures 18 3.1 Break-Even Success Probabilities for Workout Options in Various Economic Climates 45 3.2 Workout Option Support Ratios Implied by Break-Even Success Rates 45 5.1 Percent of Outstanding Loans in Foreclosure Processing 64 List of Tables 2.1 The Movement of Loans In-and-Out of Delinquency and Foreclosure Processing Over a Three Year Period 6 3.1 Workout Process Decision Tree 34 3.2 Workout Option Borrower Profiles 35 3.3 Typical Cost of Foreclosure 40 4.1 General Approaches to Insurer/Guarantor Relations With Servicers 60 5.1 Current Status of Past Defaults by Calendar Year of Default 73 5.2 Dynamics of Loan Arrearages in Assignment 78 5.3 Five-Year Trend of Mortgage Assignments 80 5.4 Status of Assigned Mortgages in the System Less Than 36 Months 82 5.5 Status of Assigned Mortgages in the System More Than 36 Months 83 5.6 VA Default Resolutions, 1991-1993 106 6.1 Major Types of Foreclosure Processes 112 6.2 State Foreclosure Times, Statutory Redemption Periods, and Availability of Deficiency Judgements 120 vi Executive Summary Introduction Section 918 of the Housing and Community Development Act of 1992 requires the U.S. Department of Housing and Urban Development (HUD) to conduct a study of mortgage foreclosure alternatives. This report fulfills that legislative mandate. Congress specifically requested a review of the foreclosure avoidance procedures used by institutions handling federally related mortgages, with special emphasis on how HUD is using its current statutory authority to provide relief from foreclosure to borrowers whose loans are insured by the Federal Housing Administration (FHA). This report documents the great strides that have been made in the mortgage industry to understand how large-scale foreclosure avoidance efforts are beneficial to borrowers and lenders alike. It also documents areas in which improvements are still necessary. For the mortgage industry as a whole, the primary improvements sought for here are increasing the number of borrowers offered loan workout options and creating more uniform foreclosure laws. The need for these is highlighted throughout the report. The Department's main recommendations include options for obtaining greater uniformity among State foreclosure laws, a call for agencies to provide better incentives for loan servicers to initiate loan modifications and forbearances, and a new statutory basis for HUD borrower relief efforts. The Problem of Foreclosures The percentage of U.S. homeowners with serious delinquency problems has been at chronic levels since 1983. Not since the Great Depression has homeownership been so tenuous, with homeownership rates actually declining for most of the 1980s. Correspondingly, single-family home foreclosure rates have been on the rise. HUD estimates that total foreclosures rose from less than 100,000 in 1981 to a peak of more than 300,000 in both 1991 and 1992. On the dark side, the statistics of the past 15 years represent 3 million American families who not only faced the financial and emotional specter of being forced from their homes, but who also suffered loss of access to credit. Additionally, they may have also experienced tax liabilities or court orders to repay lender losses on disposition of their homes. On the bright side, the severity of the foreclosure problem in the 1980s vii Executive Summary caused mortgage market organizations to look more deeply into ways in which foreclosure can be avoided. The innovations that have taken root in the mortgage industry since 1986 are bearing fruit. It is now widely understood that alternatives to foreclosure are beneficial to all parties involved: homeowners, lenders and loan servicers, mortgage insurers, and Federal guarantee agencies. Innovations now being used include methods of helping some borrowers retain their homes and others to leave them with dignity. To date, the chance of a troubled homeowner having to face foreclosure has been reduced by 10-to-15 percent from what it was 10 years ago. It is quite possible that over the next 5 years the total reduction from levels of the early 1980s can be doubled. This report outlines the issues that must be resolved to make this a reality and provides suggestions on regulatory and statutory changes that could assist the process of change.