Subprime freeze plan: Who's left out

Special Report

Seniors face grim choices amid market shock October pending home sales slip 1% Tenants victimized by foreclosures Taxpayers: Furious over homeowner bailouts

NEW YORK (CNNMoney.com) -- Distressed borrowers looking for relief from the recently announced White House foreclosure prevention plan may be in for a disappointment.

In announcing the administration's plan, which includes a five-year freeze on interest rate hikes for some subprime borrowers with adjustable-rate mortgages (ARMs), the White House estimated it would offer relief to 1.2 million families out of the 1.8 million facing higher interest rates. The initiative comes at a time of record high foreclosure rates.

But there are very strict limitations.

Sharon Reuss, a spokeswoman for the Center for responsible Lending, estimated it would help 7 percent of those stuck with unaffordable subprime loans, or 145,000 borrowers.

"This is so limited in scope," she said.

The guidelines on who can be helped are spelled out by the American Securitization Forum (ASF), which represents the players in the securitization process, including lenders, those who service the loans and investors who hold the debt.

The ASF guidelines limit the interest rate freeze solely to those borrowers who are unable to afford payments if they rise above their introductory rates. These normally adjust higher after the first two (2/28 ARMs) or three (3/27 ARMs) years of the loans.

Left out are both the people who can afford to continue payments even after rates adjust higher and those who cannot afford the loan even at the low initial rates.

Further limitations are that the loans must have been made between Jan. 1, 2005 and July 31, 2007 and have been included in securitized pools. Rates must be scheduled to reset no earlier than Jan. 1, 2008 and no later than July 31, 2010 and the restructuring process must begin before the loans reset.

To determine affordability, the plan would use readily available criteria, especially credit (FICO) scores. These must not exceed 660 or have gained more than 10 percent since the origination of the mortgage.

In either of those cases, borrowers have failed the FICO test and must apply for another type of rework. "It's very likely these people will be able to refinance into a fixed rate loan," said Tom Deutsch, Deputy Executive Director of the ASF. Deutsch helped write the guidelines.

Even if loans qualify for a freeze, servicers, according to the ASF guidelines, will not take any actions that violate contracts or applicable laws.

Additionally, the loan-to-value-ratio of the mortgage must be more than 97 percent. That is, the owner must owe more (or close to it) than the home is actually worth (see correction at end of story).

Servicers of any second mortgages on the homes must agree to cooperate.

And candidates for a freeze must be current on their monthly payments; they cannot be more than 30 days late nor have been 60 days late more than once in the previous 12 months.

Also, if borrowers qualify for an FHASecure loan, the freeze is not available to them. Borrowers must also be owner/occupiers as opposed to speculators.

And the reset has to send payments up by at least 10 percent, which should not be a difficult hurdle; typically, these loans will reset from around 7 or 8 percent to at least 9 or 10 percent.

Any modifications must maximize profits for investors and be in their best interests. Especially in a falling market, investors are usually better off taking smaller profits of modifications than major losses brought on by foreclosures.

Some critics wonder individual reworks will need to gain approvals from investors. That would be a monumental task. The loans are often carved up and sold in pieces to investors all over the world.

According to Deutsch, however, mortgage servicers have the authority to make the modifications. "A key point," he said, "is that servicers are responsible for making these decisions based on the entirety of the interest of the trust," (the investors).

According to Mary Moore, of the Center for Responsible Lending, however, servicers may have reasons of their own to pursue foreclosure rather than working with borrowers to keep them in their homes.

"Servicers can have incentives to foreclose," she said. "They sometimes have affiliates who work on foreclosures - that generates a lot of income for the affiliates."

As for the Bush plan, Moore welcomes it, but with no great enthusiasm. "We would love to see further steps," she said, "but we have no indication that more is coming."

An earlier version of this story stated that the loan-to-value ratio must be lower than 97 percent to qualify for a freeze in rates. Candidates for the freeze must have a loan-to-value ratio above 97 percent.