At the beginning of the financial crisis in 2008, borrowers of loans insured by the Federal Housing Administration (FHA) had only one likely option if they were not able to pay their mortgage and had exhausted the menu of modification and foreclosure alternatives: foreclosure. Principal reduction to lower the borrower’s monthly mortgage payments was never available to borrowers of FHA-insured loans, and short sales had severe limitations, which hampered their use.
In 2010, the Department of Housing and Urban Development (HUD), the parent agency of the FHA, began selling these distressed or nonperforming loans to investors. This pilot program has increasingly come under fire for selling assets to profit-seeking investors and some have argued that the program should require greater participation from nonprofits.
In a paper released today, we explore the concerns about the HUD program, and conclude that this program is a win-win for HUD, borrowers, and investors. Criticisms of the program, however, highlight the need for specific program improvements that would benefit all parties.
The Distressed Asset Stabilization Program
Since 2010, HUD has sold over 100,000 distressed mortgage loans to private investors. Under the Distressed Asset Stabilization Program (DASP), FHA can accept assignment of distressed mortgages from a servicer prior to a foreclosure and then sell the mortgages to private investors as nonperforming loans. The goals of the program are to maximize recoveries to FHA and, when possible, help borrowers avoid foreclosure.
To properly evaluate the loan sales, it is critically important to appreciate three key points.
DASP can prevent borrowers from going into foreclosure
The loans sold are already very delinquent. Servicers of loans in the DASP pools are required to have exhausted the HUD loss mitigation waterfall, so the loans are otherwise likely to be foreclosed upon. The impact of the program is, therefore, measurably positive for any borrower who is able to obtain a modification or foreclosure alternative as a result of the loan sale.
DASP encourages investors to pursue foreclosure alternatives
For the investor (as for the borrower), foreclosure is the worst financial outcome. And unlike the servicer of a mortgage that remains in the FHA portfolio, the investor will retain the upside financial benefit from achieving an alternative to foreclosure, thus aligning the investors’ and borrowers’ interests. Investors who purchase the loans have a wider range of options for pursuing short sales and implementing loan modifications that better align home values and payments than do servicers acting on behalf of HUD. Importantly, these investors can reduce the loan’s principal. While servicers often pursue other types of loss mitigation before principal reduction, at least some of the loans that are sold can get these mods – an outcome unavailable to loans remaining in HUD’s portfolio.
Private investors are better able to help borrowers than non-profits
While nonprofits have a role in helping delinquent borrowers, their limited capital and capacity suggests that their ability to significantly increase their share of DASP loan purchases will be limited in the near-term.
Why the main DASP criticisms are simplistic and misguided
There are three broad DASP criticisms:
- Buyers of the nonperforming loans are too quick to push borrowers into foreclosure;
- Investors are making too much money on these pools so HUD is facilitating a “massive wealth transfer” from distressed borrowers to wealthy investors; and
- Borrowers would be better served if a significantly higher percentage of these loans were sold to nonprofits.
The first two charges are simply not true. In aggregate, the loan sales programs are a win for all parties, including the borrowers. There is no question that there have been servicing abuses in the past and current servicing is not perfect. But the data show that the loans sales are producing far better outcomes for borrowers than foreclosure in the absence of the DASP.
With regard to the second criticism, there is intense competition among investors for these loans, and HUD realizes the financial benefit, as well as savings from no longer being responsible for repairs and other holding costs.
As to the third point, we question whether nonprofits have or can quickly build the capacity to service a significantly larger portion of the HUD portfolio than they are currently servicing—especially if they are working alone, and not in partnership with for-profit investors who have the capacity to conduct servicing at scale.
What are the legitimate concerns?
Some of the criticisms do reflect needed changes to the program. In particular, the DASP program should be refined to ensure that investors cannot walk away from the most distressed properties, burdening municipalities and neighbors. We also urge HUD to collect and publicly release data to provide more transparency on the amount and types of foreclosure alternatives that investors provide. Better disclosure will not only help all parties more accurately evaluate the impact of the program, but should also pressure servicers who are less borrower-friendly. Finally, we support increasing and deepening partnerships between investors and nonprofits to work with delinquent borrowers to resolve the nonperforming loans.
Additional restrictions are not, however, free to HUD and by extension, taxpayers. The costs and complexity of implementing any enhancements need to be weighed against the value of the policy objectives. The market gives very quick feedback on the costs and trade-offs, allowing HUD, market participants, and policy advocates to see what works.
Coauthor Dan Magder is the founder of Center Creek Capital Group which advises institutional investors and operating companies on policy-driven investment opportunities in the mortgage finance and financial services sectors. He was formerly the director of investments at Lone Star Funds, which has been an active participant in the HUD loan sales program, although he left nearly three years ago prior to the ramp-up in the DASP program and has not been advising Lone Star Funds since that time. This month, he will be joining a national mortgage finance company, working on a wide range of initiatives with a focus on mortgage originations for the underserved market and single-family rental. This company has participated in the HUD loan sales program in the past.