SAN DIEGO — Bank of America Corp. and JPMorgan Chase & Co. want to expand a government program designed to prevent foreclosures by adding a feature popular during the bubble years: interest-only periods.
People who might not otherwise qualify for the Treasury Department's Home Affordable Modification Program would make the cut if the rewritten loans allowed them to pay interest only for the first few years, executives from the companies argue.
"We would see a significant pickup in terms of mods with an IO feature," Doug Potolsky, the senior vice president of capital markets at JPMorgan Chase's mortgage unit, said at the Mortgage Bankers Association convention here this week.
Proponents of the idea acknowledge that the borrowers' monthly payments would jump after a few years when the interest-only period ended. But the feature would give strapped homeowners time to get back on their feet, they say.
"The view that it's not a permanent solution because it's not amortizing principal is a valid view," Steve Bailey, the default management policy executive at Bank of America, said in an interview. "But the customer and investor are willing to make the deal. A lot of these people lost the ability to make a higher payment so, in that context, to make them pay a relatively short-term interest-only loan while they recover the ability to pay strikes me as really legitimate."
Critics said that, as with so many other fixes the industry has made in the crisis, modifications with interest-only features would just delay the inevitable.
"These types of mods are all future short sales," said Robert Simpson, the founder and president of Investors Mortgage Asset Recovery Co. LLC, an audit and fraud analysis firm in Irvine, Calif. "The borrower is just paying interest on debt, and banks are protecting themselves and their cash flow."
The Treasury program gives incentive payments to mortgage servicers and investors for modifying loans so that the borrower's payment falls to 31% of income. To qualify for the program, a proposed modification must also pass a net present value test, meaning it would benefit the holder of the mortgage more than allowing it to go to foreclosure. The interest-only feature would help more borrowers pass that test because cash flow to the investor would resume right away, Bailey said.
B of A has been making modifications with interest-only periods in its own portfolio since last year, he said.
Bailey argued that, since B of A also reduces the borrower's principal at the outset, this type of modification can be viewed as an "early amortization vehicle." Reducing the balance gives borrowers "a reason to perform," he said, since they are no longer so far underwater.
It was unclear whether the interest-only idea will gain traction with the Treasury. Laurie Maggiano, director of policy in the department's Office of Homeownership Preservation, did not mention it during a speech at the conference in which she laid out several other new steps to prevent foreclosures.
Bailey and Faith Schwartz, the executive director of the Hope Now Alliance, an industry group, said they are also talking with the Treasury about a forbearance program for borrowers who have lost their jobs. Once they have found new work, these people could then be evaluated for modifications under the Home Affordable program.
Greg Hebner, the president of MOS Group Inc., an Irvine, Calif., company that contacts troubled borrowers on behalf of lenders and servicers, said servicers are motivated to bring as many borrowers current as possible because of the huge pipeline of delinquencies.
Servicers advance principal and interest payments (as well as tax, insurance, maintenance and foreclosure costs) to investors regardless of whether the borrower is paying.
When a loan is modified and recategorized as current, the servicer gets reimbursed for those advances, which is a strong motivation to modify as many borrowers as possible, Hebner said.
"They want a reperforming loan," he said. A modification with an interest-only period "could be a bet that in another year or two the market will improve."
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Corrected October 15, 2009 at 5:23PM: An earlier version of this story misstated the first name of a JPMorgan Chase executive. He is Doug, not David, Potolsky. An editing error was to blame.