HAMP - Principal Forgiveness and Interest Rate Step-ups
Some thoughts on two important topics:
The Principal Reduction Alternative (PRA): part of the Home Affordable Modification Program (HAMP). PRA is a deferred principal reduction program that allows a borrower to earn principal reduction over a three-year period.
The deferred principal reduction amount is initially treated as non-interest bearing principal forbearance.
On the first, second and third anniversaries of the borrower’s trial period effective date, one-third of the original principal reduction amount will be forgiven as long as the borrower remains in good standing.
PRA gives servicers the flexibility to offer principal reduction relief to borrowers whose homes are worth significantly less than the remaining amounts due on their first lien mortgage loan.
Under PRA, servicers are required to evaluate the benefit of principal reduction for every HAMP eligible loan with a MTMLTV ratio greater than 115% and are encouraged to offer principal reduction whenever the net present value (NPV) result of a HAMP modification using PRA is positive.
Servicers must use both the standard HAMP modification waterfall and an Alternative modification waterfall that includes principal reduction as the second step in the waterfall.
Servicers are required to evaluate all such loans using a standard NPV test that compares the NPV results for modifications both with and without PRA to the NPV result without a modification.
In addition to the required NPV test, servicers may conduct other evaluations to determine the level of principal reduction that is in the best interest of investors.
HAMP Interest Rate Step-up
For some HAMP homeowners, interest rate step-ups will begin this month, impacting approximately 30,000 HAMP homeowners by the end of the year, all of whom received modifications in 2009.
Approximately 80 percent of homeowners with a HAMP Tier 1 modification will experience at least one future rate step-up. The majority of HAMP homeowners will experience two or three rate step-ups. The number of rate step-ups and the amount of the payment increase will vary depending on the effective date of the modification, whether the modification included principal forgiveness and other factors.
The maximum rate depends on the market rate at time of modification. For 92% of HAMP homeowners this will result in a rate at or below 5%.
For our analysis, we were able to locate approximately 100,000 ($24.7 billion) active HAMP modifications in Private Label Securities with a Step-up feature. The chart below shows the expected payment shock given the number of step-ups used. Since most of the rate increases take place over 2-3 steps, on average, borrowers will experience a 15% payment increase at the first step-up date.
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