Distressed Homeowners Get New Options in Plan

By DEBORAH SOLOMON

WASHINGTON -- President Barack Obama's plan to aid troubled homeowners, set to be unveiled Wednesday, will include efforts to cut monthly mortgage payments, allow more borrowers to refinance their loans and give bankruptcy judges greater power to modify mortgages, according to people familiar with the proposal.

The array of options fills in some of the blanks left by Treasury Secretary Timothy Geithner last week when he unveiled the Obama administration's overhaul of the $700 billion financial-system bailout plan, which he said included an as-yet-to-be-outlined new approach to housing. Many economists say addressing the cycle of foreclosures and falling home prices is one key to ending the financial crisis.

Barack Obama

At the heart of the plan is an effort to make loans more affordable by providing a government subsidy to help mortgage companies modify certain troubled loans. The administration is expected to kick in $50 billion out of the bailout fund to help mortgage companies with the costs of such an effort.

In addition, the administration is expected in the Wednesday announcement to detail a program that will allow homeowners who owe more than their homes are worth to refinance their mortgages, something that currently isn't possible. Amid fears that some of these borrowers may default, the administration would use government-controlled mortgage giants Fannie Mae and Freddie Mac to assist such borrowers who are still current on their payments. Such a move would put the mortgage companies at the center of any housing recovery but could also lead to them taking on greater losses. Although the government runs much of their affairs, both retain private shareholders and have never been used this way before. They can borrow billions of dollars from the government and the Obama administration might find using those funds more palatable than asking Congress for more money.

The Obama plan would represent one of the most ambitious efforts yet to tackle the housing-market problems that helped trigger the financial crisis. The Bush administration created several voluntary plans implemented by the mortgage industry, most of which had little impact. Until housing prices stop falling, economists say, banks won't be certain about the extent of their losses, prolonging the lack of confidence that has slowed lending, as well as consumer and business activity.

Devising a comprehensive solution has posed political and financial challenges. The aim is to help homeowners without rewarding risky behavior or spending hundreds of billions of dollars. It's hard for the government to compel mortgage companies to rewrite the terms of loans. Also, such plans tend to raise the ire of homeowners who have been diligently making regular mortgage payments.

To make loans more affordable, the Obama administration is expected to support a mix of efforts, including lowering interest rates or lengthening the term of some loans, said people familiar with the plans.

Because any reduction in monthly payments will hurt the bank or investor who owns the loan, the government is expected to help defray the costs with a subsidy. That could take the form of a direct payment. The government could also match, point by point, any interest-rate reduction made by the servicer. The administration may provide between $800 to $1,000 per loan, according to a financial-services representative familiar with the plans.

The goal is to compensate banks or investors who own the loans if they reduce payments to a certain level, possibly as low as 31% of a borrower's pretax income. In addition, the administration could indemnify mortgage servicers from being sued by investors angered by any changes made to the loan agreements. This is important because many loans have been repackaged and sold to investors.

To determine who qualifies for a lower monthly payment, the administration is expected to look at homeowners' debt-to-income ratio, these people said.

There is a big debate among housing experts as to whether reducing interest payments, as opposed to cutting into the principal, makes enough of a difference to keep people in their homes. Some evidence suggests borrowers quickly run into trouble again even if their monthly payments are reduced. Thus far, the administration's plan doesn't appear to include reducing the principal owed on homeowners' loans.

Instead, in a move designed to push mortgage companies to take such action themselves, the administration is expected to make it easier for judges to modify mortgages during bankruptcy proceedings. The mortgage industry has long fought such a move, arguing that it is costly, cumbersome and could lead to higher rates for everyone. Opposition from big banks has softened since the election when it became clear such a move was in the offing.

Many of the housing plans considered by the Obama and Bush administrations have suffered from one big problem: It isn't clear how the government can prevent people from halting payments in order to qualify for help.

To address that, Mr. Obama's plan may require that homeowners eventually pay back the difference between the original payment and the reduced rate. While borrowers would get a lower monthly payment, they would still technically owe a big additional payment at the end of their loan's term. That could be covered by the rise in a home's value, assuming the market recovers.

Mr. Obama hinted at such a move at a town hall meeting in Florida last week, saying, "The borrower is going to have to probably -- if they get some assistance -- agree to give up some equity once housing prices recover so that both sides are giving a little bit."

The administration is also expected to create national standards for loan modifications to be adopted by Fannie Mae and Freddie Mac. The plan could include a mechanism to determine the value of homes facing foreclosure. The difficulty of valuing such homes is one reason many loan-modification efforts have stalled. Administration officials believe the plan, combined with efforts to aid banks and the $787 billion economic stimulus that Mr. Obama signed into law Tuesday, will help pull the economy out of recession.

Mr. Obama, Treasury Secretary Geithner and Housing and Urban Development Secretary Shaun Donovan are set to announce the plan in Arizona. The state had the third-highest foreclosure-filing rate in the nation in January, according to foreclosure tracking firm RealtyTrac Inc.

Write to Deborah Solomon at deborah.solomon@wsj.com