The value of HAMP's enhancement

In December 2014, Treasury Department sweetened the deal for borrowers in the Home Affordable Modification Program (HAMP).

‘Pay for performance’ and re-amortization enhancement

In addition to the reduced rates and favorable terms to promote sustainable homeownership, HAMP also offers a $1,000-per-year principal reduction for the first five years as an incentive to stay current on payments. To this, the Treasury is now adding a $5,000 principal reduction for folks still in active modifications after the sixth year.

As well, servicers have been directed by the Treasury to re-amortize this lowered balance over the remaining term, which may or may not lower the monthly payment by much, but will produce considerable savings for borrowers over the long term.

A free cash-in refinance

Essentially, this is providing a cash-in refinance to certain borrowers at no cost and with no re-extension of the loan term, a deal plenty of non-HAMP borrowers would love to have been offered, most especially the $10,000 principal reduction. The Treasury estimates that about one million people will receive the added benefit. 

By the numbers

To get a sense of how this "pay for performance" and re-amortization enhancement benefits HAMP borrowers, we ran the numbers on three scenarios to see how much benefit might accrue to a homeowner in a HAMP mod. We compared:

1. A standard, non-HAMP loan at 5%
2. A HAMP loan with no rate reduction (5%) but a simple term reset to a new 30 years
3. A HAMP loan that included a 1-percent rate reduction for the first five years, then a 1 percent “step-up” in interest rate for the remainder of the term

We then looked at the costs of a new 30-year term with the existing $1,000-per-year principal reduction, and then added to this the new $5,000 paydown at the end of year six and a re-amortization of the loan. To calculate the benefit to HAMP borrowers, we compared the costs of these modified loans against a standard, non-HAMP borrower for a $200,000 loan:

More mod, more value

This example shows that HAMP borrowers who received at least a one percentage point reduction in their interest rate for the first five years, a $1,000-per-year principal reduction in the first five years, and the new $5,000 paydown in the sixth year have saved tens of thousands of dollars more compared to their counterparts.

It's instructive to remember that the purpose of HAMP was to promote sustainable homeownership, predominately though the use of loan modifications which produced a debt-to-income (DTI) ratio not more than 31 percent of a borrower’s monthly gross income. The "reward" itself was supposed to be that troubled borrowers might avoid foreclosure, or at the least avoid needing to sell into a weak market at a potential loss.

A perverse reward arrangement

While no doubt a noble concept, a claim could be made that this enhancement is a kind of perverse reward arrangement. HAMP borrowers already were receiving meaningful and tangible benefits -- e.g. they got to keep their home plus a $1,000-per-year principal reduction -- but the new $5,000 "pay for performance" enhancement, coupled with a re-amortization of the loan provides a considerable additional benefit, one which isn't the result of any kind of hardship or need, and one a traditional borrower would love to have.

The additional principal reduction may produce another financial advantage for HAMP borrowers: If all three loans in our example require MI, the total of a $10,000 paydown of principal gives either HAMP borrowers a distinct advantage as the HAMP borrowers would be much closer to a cancellation point of their mortgage insurance than would a traditional borrower.

Given these substantial financial advantages, a traditional mortgage holder is likely asking: "Where can I sign up?"

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