From Financial Times Alphaville --
Just a datapoint for you, as the debate over the US Treasury’s Hamp programme rages on.
As a reminder, the Home Affordable Modification Plan aims to help keep people in their houses primarily by lowering interest rate payments. It’s not had a lot of success so far, so people are starting to look at possible ways to rejig the programme. One of those is principal forgiveness, instead of just forbearance, for underwater homeowners.
But there’s one big thing standing in the way of principal reduction; second lien mortgages, or second mortgages taken out on a property (like secured loans on mortgaged properties in the UK).
Normally second lien mortgages rank subordinate to the first mortgage (first lien). In principle, that means if the property is sold or the borrower defaults, the first lien lender is first in line to get the resulting money, followed by the second lien lender.
When mortgage modifications like Hamp come into play, that traditional priority order is reversed. The borrower is paying the Hamp-modified (i.e. lower) first lien amount, and the full second lien amount, so the second lien effectively becomes senior to the first.
When principal reduction comes into play, the problem becomes even starker. Current rules say that first lien mortgages can’t be written down before the second.
So second lien loans are a rather big-stumbling block in the Treasury’s mortgage programme. To make matters worse, as we’ve noted before, banks are some of the biggest holders of second mortgages.
That means they’re basically disincentivised to modify or write-down first mortgages, at the expense of second ones. Thus, Bank of America to our knowledge is the only bank to have signed up for the second lien portion of the Hamp (called 2MP) so far.
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http://ftalphaville.ft.com/blog/2010/02/05/143036/the-second-lien-sticking-point/