The Obama administration is expected to announce details this week on a supplement to its foreclosure prevention plan designed to address the problem of second mortgages, sources said.
Investors holding securitized first mortgages have argued that the administration's plan to modify borrowers' home loans by reducing monthly payments on first mortgages is ineffective and unfair because it does not change the terms on existing second mortgages.
Under a new plan expected to be announced by the Treasury Department this week, the administration is expected to offer two different approaches.
Under one, the two mortgages would be required to be modified simultaneously. But the Treasury is also considering using money from the Troubled Asset Relief Program to partly pay off second-lien holders in exchange for a release, a source told American Banker.
As it stands now, the administration's foreclosure prevention plan directs servicers to modify primary mortgages so that borrowers' debt-to-income ratio is brought down to 31%. Borrowers would then receive an additional supplement from the government to help with monthly payments. The second mortgages, so far, are not required to be modified at all.
Investors protested that this approach ignored the reality that second mortgages are riskier investments and are reaping the benefits of any modification, which leaves a first-lien holder at a disadvantage and a second-lien holder's status unchanged.
Several had threatened to sue the government over the program, arguing second-lien holders should be forced to take a loss as well.
The new supplements to the plan are designed to confront that issue.
The source, who had seen a draft that was not yet final, said that for most borrowers the second mortgage would be modified along with the first, though the program would still require the first mortgage to be modified so that it alone provided the borrower with a 31% debt-to-income ratio before the supplementary payments from the government.
Holders of second mortgages on properties that were underwater, meanwhile, would be paid a sum of money to release the borrower from his or her obligation.
Currently, when a property with a loan-to-value ratio of 100% or more is foreclosed upon, any second mortgage holders are wiped out entirely and do not receive money or a share in the value of the foreclosed property.
Under the new plan, in the case of borrowers with second mortgages who are underwater on their properties those with loan-to-value ratios of more than 100% the second-lien holder would receive a lump sum from Tarp in exchange for a release of the obligation. The size of the payment to second-lien holders would likely follow a schedule first designed for the Federal Housing Administration's Hope for Homeowners plan, which granted second-lien holders on properties with loan-to-value ratios of less than or equal to 135% a total of 4% of the value of the mortgage up front.
Details on the procedure for other alternatives to foreclosure, such as deeds in lieu and short sales, are also likely to be released during the same announcement this week.
Borrowers who do not qualify for a loan modification under the Obama administration's plan may still arrange for a short sale, or to give the bank a clear title to the house, which would require eliminating home improvement liens and second mortgages. These options, too, could require government assistance.