Under the regulatory agency's proposal, still in its early stages, these borrowers would refinance into government-insured loans that cover the current value of their homes. The refinancing would pay part of what's owed to the original lender. For the remainder, the lender would get what the plan's backers call a "negative equity certificate." The lender could redeem the certificate if the home is eventually sold at a higher price.
The plan is a sharp change from the way troubled mortgages are handled now. It is the latest government initiative aimed at containing the mortgage market mess that surfaced last year when subprime borrowers began defaulting at an alarming rate. The administration and Congress have weighed in with their own plans in recent months, and the OTS proposal is meant to dovetail with those. "We're trying to find something that could operate in tandem with all these other proposals" without taking the borrower off the hook and without using taxpayer money, said Kevin Petrasic, an OTS spokesman. "We want to avoid having people walk away from their homes."
The agency, which has been closely involved in talks about government responses to the mortgage problems, focused on borrowers whose home values have plummeted because a growing number of people are in that situation and unable to refinance.
The proposal was briefly mentioned at a regular quarterly news briefing. More details should emerge over coming weeks, Petrasic said. The plan has been extensively analyzed internally and is now being discussed with policymakers and industry officials, he said.
The plan would separate a troubled mortgage into two parts. The first would cover the current fair-market value of the home and would be refinanced by the Federal Housing Administration. The remainder would be issued to the original lender as a certificate.
If the borrower eventually sells the home, the FHA mortgage would be paid off first. Remaining cash would be applied to paying off the value of that certificate. Anything left over would go to the borrower.
If there's not enough profit to pay off the certificate, the original lender would take a loss, which makes this proposal a gamble. However, the plan anticipates that there would be a market where these certificates are traded. That means the lenders could sell them immediately to offset some of the loss or hold them with the hope that they will appreciate, said Jaret Seiberg, an analyst at Stanford Policy Research.
The certificates would likely trade for small amounts, maybe $2 for every $100 in home value, and the amounts would increase as the housing market strengthens, Seiberg said.
But there are still many political and logistical hurdles.
This plan has not been vetted by the White House, Congress or other policymakers. The FHA declined to comment on the specifics except to say it is "regularly looking at new ideas and actively exploring ways to expand the eligible pool of creditworthy borrowers FHA can serve."
Whether investors will embrace the idea depends on many details that aren't resolved, Seiberg said. But it could be a way for lenders to cut their losses. "It beats foreclosure," Seiberg said. "These certificates enable [investors] to share in the upside if the housing market recovers."
For borrowers, avoiding foreclosure means they get to keep their homes and reduce damage to their credit.
"What we tried to do is figure out the best way to create market incentives for all the parties involved," Petrasic said.