Mortgage lenders would receive greater credit for lowering payments on loans for troubled homeowners who have more equity in their properties than for providing relief to borrowers with less equity, under the terms of a proposed $25 billion settlement between the nation's five largest banks, attorneys general in nearly every state, and the Obama administration, according to a partial draft of the settlement reviewed by The Huffington Post.
(UPDATE: This story has been updated to reflect conversations with senior Obama administration officials.)
Senior administration officials, who spoke on condition they not be named, portrayed this incentive structure as beneficial to distressed homeowners, not least to the most deeply underwater borrowers - those who owe banks far more than their homes are worth. The mere fact that the settlement includes assistance to homeowners whose properties are well underwater provides assurance that banks will not overlook the most high-risk cases, the officials said.
Under the formula governing the settlement, helping borrowers with severely underwater loans will sometimes earn banks more credit than when they provide relief to borrowers who own more equity, the officials added.
The proposed deal would exempt mortgage companies from applicable civil fines on illegal foreclosure practices for up to one percent of all of their loans, according to the draft. A senior administration official said a monitoring committee tasked with overseeing the settlement would hold mortgage lenders accountable for all such instances, while requiring remedies.
But some consumer advocates familiar with the terms expressed disappointment, asserting that it lacks assurances that severely underwater borrowers would receive broad relief.
Roughly one in five American mortgages are now underwater. Housing experts have urged the Obama administration to craft a settlement that would write down outstanding loan balances on properties with high loan-to-value ratios, meaning those for which the borrower owes much more than the house is worth. Otherwise, they warn, large numbers of borrowers will have no incentive to continue making payments and simply relinquish homes to lenders.
"To really make a difference in the housing crisis, you have to assist high [loan-to-value] homeowners," said Diane Thompson, an attorney at the National Consumer Law Center. "Otherwise, at some point, they're all going to walk away from their homes."
Administration officials maintained that the incentive structure in the current version of the settlement would motivate banks to reach these high loan-to-value borrowers.
"Given that borrowers who are most severely underwater have higher rates of defaulting on their mortgages, those loans are worth less to the banks who are already assuming the borrower will default," said one official. "Why should we overpay by giving banks a larger incentive than necessary?"
Some consumer advocates agree with that logic. The Center for Responsible Lending, a nonprofit organization that advocates for fair lending standards, supports the deal. In a statement released last week, the Center called the proposed terms "a significant reform of mortgage servicing," adding that it would "provide an important template for ways banks can use principal reduction to reduce unnecessary foreclosures and put the country back on a path to economic recovery."
The banks have long resisted calls to forgive large portions of loan balances and have been unwilling to absorb losses. The current settlement terms appear to satisfy the banks on this point, some observers said, minimizing the pressure to hand out relief to severely underwater borrowers.
"That's in some sense what the banks wanted," said Thompson, calling the proposed terms "the price of getting the deal done."
The settlement aims to help underwater homeowners by requiring banks to lower these borrowers' payments -- by reducing interest rates on their loans, enabling them to refinance or by cutting their principal amount.
Under this proposal, the banks would collectively pledge to provide roughly $25 billion toward helping troubled homeowners. But the banks would receive greater credit toward satisfying the terms of the deal when they help borrowers who owe less than 175 percent of the value of their homes. Helping borrowers who owe more than 175 percent would qualify for less credit, according to the draft of the proposed settlement.
The settlement is expected to be announced by the White House sometime next week. The Obama administration has given state attorneys general until Monday to sign on to the deal, according to state officials who spoke on condition they not be named.
The settlement on the table is the product of more than a year of talks, a complex set of negotiations aimed at settling claims of wrongful foreclosure and other abuses by five major financial institutions -- Bank of America, JPMorgan Chase, Citigroup, Wells Fargo and Ally Financial -- in the so-called robo-signing scandal. Banks have faced widespread accusations that they employed law firms that forged required signatures on millions of loan documents, resulting in wrongful foreclosures.
The Obama administration, confronting accusations that it has failed to pursue justice against the institutions responsible for a national foreclosure crisis, has been eager to secure a grand, headline-capturing deal involving every state and all the biggest lenders. But some key states -- not least California -- remain hesitant to sign on, arguing that the deal would hand out too much forgiveness in exchange for too little benefit for distressed homeowners.
The provision exempting banks on fines for illegal foreclosure practices on up to 1 percent of their mortgages is accompanied by a mechanism that would enable states to continue to prosecute such instances.
Under the draft seen by the HuffPost, states whose residents appear to be victims of illegal foreclosures could take such cases to a committee headed by North Carolina's banking commissioner, Joseph Smith. The committee would rule on whether the foreclosure was illegal, requiring the bank to fix any problems. Banks would be immune to civil fines for up to 1 percent of their loans.
Consumer advocates expressed concerns about that mechanism.
"Having an allowable erroneous foreclosure rate makes practical sense," said Melissa Huelsman, a Seattle attorney who represents homeowners in foreclosure cases. "But I don't like that the appeal has to go through a committee. With these bureaucratic committees, it can take months and months to get anything done. Meantime, what happens to the homeowners being harmed?"
Senior administration officials expressed confidence that the mechanism would prove effective.
"The monitor will immediately bring any and all erroneous foreclosures to servicers, who must resolve them immediately," said one official. "The margin of error that we allow is only to make sure that if there is some sort of systemic failure in that process, we can flag it and distinguish it and correct it."