Loan Modification for IndyMac Mortgages?

A recent JP Morgan report clarified exactly what the FDIC meant by "principal forbearance." The FDIC approach is to arrive at a total HTI (housing-to-income) ratio of 38% for the mortgage holder of the IndyMac “Option ARM” loan.

This 38% may be achieved by using one or more of the following restructuring paths:

1) The interest rate can be lowered to the current Freddie Mac survey rate for fixed rate loans and, then, fully amortized as a fixed rate mortgage. Subsequently, the loan will then be amortized over the remaining number of years left in the original term.

2) The interest rate is "stepped down" (changed to a pseudo-graduated payment loan) for as many as five years. The initial rate will be set no lower than 3% the first year, and proceed, increasing each year by no more than 1% each year. This continues until the rate hits the Freddie Mac survey rate (which was 6.5% at the time FDIC published).

Note: This doesn’t convert the loan to an ARM or cause negative amortization, as the payment is re-amortized each year after the interest rate "steps up." This process is repeated until the rate hits the permanent rate. That means that each year the borrower is paying some principal on the loan from the onset of the modification.

ARM loans hold the potential for increases in their rate depending on unknown changes in the underlying index over time. A "graduated payment loan," such as this one, has scheduled rate increases that are determined in advance and laid out in the modification agreement. This means the payment changes will be predictable regardless of where market interest rates go between year one to year four.

In this plan, the borrower receives the long-term "rate lock" security of a fixed rate loan and an ultimate rate that will never exceed 6.50% (or whatever the Freddie rate is on the day the loan modification is finalized) nor will it ever drop below their start rate of their modification plan.

This plan slowly "graduates" the borrower into the fully-amortized final payment by starting out at a lower rate and increasing it each year until the final 6.5% rate is reached.

3) The entire loan is recalculated using a 40-year amortization instead of the remaining term of the loan. If the loan was originally a 40-year term, as were many Option ARMs, this choice will have no effect. If the loan was originally a 30-year, this step may reduce the payment enough to hit the 38% level.

4) The main point is the FDIC’s definition of "principal forbearance" is not what most people think they mean by "principal reduction."

The JP Morgan analysts said the maximum principal forbearances on the IndyMac portfolio aren't likely to be huge.