Rate freeze plan for ARMs gains traction

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NEW YORK (CNNMoney.com) -- If you've got a 7% adjustable mortgage that's about to skyrocket past 10%, getting a break may get a lot easier. One solution to the foreclosure problem gaining traction would freeze rates at lower levels.

The Hope Now Alliance, a coalition of lenders, servicers, investors and community groups, put together by the Treasury Department, is working on a version of a freeze that could be annouced this week.

Lenders quietly began offering such freezes during the summer. Last week California officials announced a rate-freeze deal with four major lenders.

Details of the Hope Now plan have not been finalized, according to Kurt Pfotenhauer, a senior vice president for government affairs with the Mortgage Bankers Association, which is part of the Alliance.

Treasury Secretary Henry Paulson has been hashing out the plan's details with other top regulators, loan servicing companies and banks, including JPMorgan Chase & Co. and Wells Fargo & Co. Paulson is scheduled to speak at a housing forum in Washington Monday morning.

For a borrower with an adjustable rate mortgage (ARM) at 7 percent on a $200,000 loan, a freeze would mean substantial savings. If the loan were to reset to 10 percent, the monthly payment would jump from $1,331 to $1,755.

Judging from other lenders' plans, a reset freeze would be available only to those borrowers judged unable to make payments at the reset rates.

That would be determined based on a borrowers' debt and income, according to Pfotenhauer, who could not specify what standard Hope Now will use. Historically, the lending industry judged affordability in this way: Total debt payments each month should not exceed 36% of total income. But in a bill sponsored by Barney Frank (D- Mass.), that threshold is set much higher, at 50%, according to Pfotenhauer.

Borrowers for whom loans are unaffordable even at the initial rates would likely not qualify, as is the case in current programs offered by Countrywide and other lenders.

And borrowers with enough income to pay the higher reset rates may also not qualify for a freeze. Many of these good payers, however, have the option of refinancing. A huge segment of this group is already refinancing just fine, according to a lending industry spokeswoman, speaking on background.

But not all borrowers in good standing are able to take advantage of refinancing, according to John Taylor, president of the National Community Reinvestment Coalition. Many of these borrowers own homes that were appraised much above actual values when they bought in 2005 and 2006 and market prices have dropped since.

These under-water borrowers might not be able to refinance because lenders are no longer willing to advance more than 100 percent of home equity.

Taylor believes it's only fair that these borrowers be offered the same freeze as the one unable to afford higher rates.

"They too, were hood-winked into these loans because of the absence of regulatory enforcement," Taylor said. "All these borrowers relied on the mortgage lending system but integrity went out the window when Wall Street said, 'We'll buy anything, even loans from people we know couldn't afford them.'"

A freeze was proposed in early October by Sheila Bair, chairwoman of the Federal Deposit Insurance Corporation (FDIC), according to FDIC spokesman, Andrew Gray. It has been well received. Both the Wall Street Journal and the New York Times endorsed it.

Bair first had the idea in April, said Gray. But in September, Moody's revealed that only 1% of ARM borrowers with loans that reset to higher interest rates in 2007 were modified in any way.

"That spurred Bair to go public," said Gray. "We were looking for a way to deal with the massive resets occurring in the fourth quarter of 2007 and early 2008," Gray said. "The problem is too big to do on a case-by-case basis."

More lenders have become receptive to loan workouts. Foreclosure prevention counselors report that mortgage servicers have begun to restructure many more ARMs. But the modifications were all being done on a case-by-case basis.

And the volume of subprime ARM loans resetting is so huge - $362 billion in 2008, according to Banc of America Securities - it threatens to overwhelm efforts to address the problem. About 1.5 million borrowers face default through 2008, according to Gray. More than 300,000 homeowners have already lost their homes.

The freeze could be good for everyone, according to Gray. "Borrowers get to stay in their homes," he said. "Neighbors don't face declines in home values. Lenders continue to profit at fairly high interest rates."

Even the subprime borrowers it leaves out draw some benefit. It may free up loan counselors to provide them with more personalized help.

"There'll be other opportunities to help some of the other ARM borrowers," said Gray. "With the big numbers out of the way, the focus can be on the other categories of borrowers."