Representative Barney Frank (D-MA) told a subcommittee today that what he termed “lackluster” efforts on the part of servicers is increasing the chances that new bankruptcy legislation will pass.

Even as the chairman of the House Financial Service Committee was warning loan servicers about possible fallout from poor loan modification performance, a Treasury official was testifying that things are improving.

Frank said that he is continuing to pursue legislation which will allow the courts to reduce or “cram down” mortgage loan amounts to reflect actual property values for borrowers in the process of bankruptcy.

"The best lobbyists we have for getting bankruptcy legislation passed are the servicers who are not doing a very good job of modifying mortgages," Rep. Barney Frank said at a panel subcommittee hearing. "If they do not improve their performance then they improve their chances of that legislation."

However, according to written testimony submitted to the House Financial Services Subcommittee on Housing and Community Opportunity which is holding hearings on Stabilizing the Housing Market, Michael Barr, Treasury's assistant secretary for financial institutions said that good progress is being made under the Treasury Department’s Home Affordable Modification Program (HAMP.)

Over 45 servicers have signed up to participate in HAMP including the nation’s five largest servicers.  They have extended offers on over 570,000 trial loan modifications under the program initiated by the Department in February

Barr told the representatives that over 360,000 trial modifications were underway by the end of August, nearly a 50 percent increase from the 235,247 reported at the end of July.   To date participating servicers have sent 1.88 million requests for financial information to borrowers.

Between loans covered by these servicers and loans owned or guaranteed by Freddie Mac and Fannie Mae, more than 85% of loans in the country are now covered by the program.

HAMP is a $75 billion piece of the larger Making Home Affordable (MHA) Program.  According to Barr, “it supports loan modifications that will provide sustainable, affordable mortgage payments for up to 3 to 4 million borrowers.”   HAMP offers "pay-for success" incentives to investors, lenders, servicers, and homeowners for successful mortgage modifications.  There are clear signs that these incentives are having a substantial effect, he said.

The HAMP program establishes detailed guidelines for the industry to use in making modifications with the goal of encouraging the industry to adopt an affordable standard for use outside the program as well.  Barr said that in the past a lack of such guidelines has limited the number of loan modifications even where they would be beneficial to all involved.

The guidelines prevent mortgage servicers from “cherry-picking” loans in a manner which might deny assistance to those borrowers most in need of assistances.  Servicers are required to service all loans in their portfolio under the guidelines unless otherwise prohibited by pooling and servicing agreements and must make a good faith attempt to modify those agreements.  They are also required to evaluate every eligible loan using a standard net present value test which compares the net present value of cash flows with modification and without.  If the test is positive the servicer must modify the loan.

The program was originally designed to help homeowners whose existing mortgages were up to 105 percent of their current house value, but it has since been expanded to help those with mortgages up to 125 percent of current value.  Under the program’s guidelines every modification must lower the borrower’s monthly mortgage payment to 31 percent of the borrower’s monthly gross income.

To reach 31 percent the servicers can reduce the interest rate to as little as 2 percent, extend the term of the loan to as much as 40 years, and, if necessary, forebear principal until the 31 percent ratio is achieved.  The 31 percent debt to income ratio will remain in place for five years as long as the borrower remains current.  The interest rate will step up each year to a specified cap.

To encourage servicer participation HAMP offers “pay for success” incentives to servicers, investors, and borrowers for successful modifications.  Servicers receive an up-front payment of $1,000 for each successful modification after completion of the required three month trial period and additional payments of up to $1000 per year for each year the borrower remains current.  Homeowners may earn up to $1000 in principal reduction each year for five years if they pay as agreed.

HAMP also matches reductions in monthly payments dollar-for-dollar with the lender/investor from 38 percent to 31 percent DTI.  This requires the lender/investor to take the first loss in reducing the borrower payment down to a 38 percent DTI, holding lenders/investors accountable for unaffordable loans they may have extended.

Barr said that “At this early date, HAMP has already been more successful than any previous similar program in modifying mortgages for at risk borrowers to sustainably affordable levels, and helping to avoid preventable foreclosures.”

Nonetheless, he said, challenges remain and the program is focused on addressing improvements in servicer capacity, transparency of effort, and borrower outreach.

In July servicers were asked to commit to reaching a cumulative target of 500,000 trial modifications started by November 1, 2009.  Barr said they were on track to meet that goal.