The subprime market segment generally serves borrowers with blemished  credit and features higher interest rates and fees than the prime market. One of the main sources of information on the status of mortgage loans is  the Mortgage Bankers Association’s quarterly National Delinquency  Survey. The Emergency Economic Stabilization Act, passed by Congress and  signed by the President on October 3, 2008, created TARP, which outlines  a troubled asset purchase and insurance program, among other things. Default and Foreclosure Rates Have Reached Historical Highs and Are Expected to Increase Further

National default and foreclosure rates rose sharply during the 3-year  period from the second quarter of 2005 through the second quarter of 2008  to the highest level in 29 years (fig.1). Put another way, nearly half a  million mortgages entered the foreclosure process in the second quarter of  2008, compared with about 150,000 in the second quarter of 2005. ARMs accounted for a disproportionate share of the increase in the  number of loans in default and foreclosure in the prime and subprime  market segments over the 3-year period. Default and foreclosure rates also varied significantly among states. Every state in the  nation experienced growth in their foreclosure start rates from the second  quarter of 2005 through the second quarter of 2008. The foreclosure start rate rose at least  10  percent in every state over the 3-year period, but 23 states experienced a increase of 100 percent or more. Several states in the “Sun Belt” region,  such as Arizona, California, Florida, and Nevada, had among the highest  percentage increases in foreclosure start rates. Treasury’s initial focus in implementing TARP  was to stabilize the financial markets and stimulate lending to businesses  and consumers by purchasing troubled mortgage-related assets— securities and whole loans—from financial institutions. Treasury planned  to use its leverage as a major purchaser of troubled mortgages to work  with servicers and achieve more aggressive mortgage modification  standards. The recitals refer to the participating  institutions’ future actions in general terms—for example, “the Company  agrees to work diligently, under existing programs to modify the terms of  residential mortgages as appropriate to strengthen the health of the U.S.  housing market.” Treasury and the regulators have publicly stated that  they expect these institutions to use the funds in a manner consistent with  the goals of the program, which include both the expansion of the flow of  credit and the modification of the terms of residential mortgages. But, to  date it remains unclear how OFS and the regulators will monitor how  participating institutions are using the capital injections to advance the  purposes of the act. In our first   60-day report to Congress on TARP, mandated by the Emergency  Economic Stabilization Act, we recommended that Treasury, among other  things, work with the bank regulators to establish a systematic means for  determining and reporting on whether financial institutions’ activities are  generally consistent with the purposes of CPP. Treasury has established and appointed an interim chief for the  Office of the Chief of Homeownership Preservation under OFS. Treasury has stated that it is working with other federal  agencies, including FDIC, HUD, and FHFA to explore options to help  homeowners under TARP. However, to date the Treasury has not completed its strategy for  preserving homeownership. Treasury also points to challenges in financing any new proposal. We will continue to monitor Treasury’s efforts as part of our  ongoing TARP oversight responsibilities. Appendix I: Examples of Federal Government and Private Sector Residential Mortgage Loan Modification Programs

Eligible borrowers are those with loans owned or serviced by IndyMac Federal Bank  Affordable mortgage payment achieved for the seriously delinquent or in default borrower  through interest rate reduction, amortization term extension, and/or principal forbearance  Payment must be no more than 38 percent of the borrower’s monthly gross income  Losses to investor minimized through a net present value test that confirms that the  modification will cost the investor less than foreclosure  Borrowers can refinance into an affordable loan insured by FHA  Eligible borrowers are those who, among other factors, as of March 2008, had total  monthly mortgage payments due of more than 31 percent of their gross monthly income    New insured mortgages cannot exceed 96.5 percent of the current loan-to-value ratio  (LTV) for borrowers whose mortgage payments do not exceed 31 percent of their monthly  gross income and total household debt not to exceed 43 percent; alternatively, the program  allows for a 90 percent LTV for borrowers with debt-to-income ratios as high as 38  (mortgage payment) and 50 percent (total household debt)
Requires lenders to write down the existing mortgage amounts to either of the two LTV  Eligible borrowers are those who, among other factors, have missed three payments or  more  Servicers can modify existing loans into a Freddie Mae or Fannie Mac loan, or a portfolio  loan with a participating investor  An affordable mortgage payment, of no more than 38 percent of the borrower’s monthly  gross income, is achieved for the borrower through a mix of reducing the mortgage interest  rate, extending the life of the loan or deferring payment on part of the principal  Eligible borrowers are those with subprime or pay option adjustable rate mortgages  serviced by Countrywide and originated by Countrywide prior to December 31, 2007    Options for modification include refinance under the FHA HOPE for Homeowners program,  interest rate reductions, and principal reduction for pay option adjustable rate mortgages  First-year payments mortgage payments will be targeted at 34 percent of the borrower’s  income, but may go as high as 42 percent  Annual principal and interest payments will increase at limited step-rate adjustments  Affordable mortgage payment achieved for the borrower at risk of default through interest  rate reduction and/or principal forbearance    Modification may also include modifying pay-option ARMs to 30-year, fixed-rate loans or  interest-only payments for 10 years    Modification includes flexible eligibility criteria on origination dates, loan-to-value ratios, rate  floors and step-up adjustment features  This program was created in consultation with Fannie Mae, Freddie Mac, HOPE NOW and  its twenty-seven servicer partners, the Department of the Treasury, FHA and FHFA.
Why GAO Did This Study

A dramatic increase in mortgage loan defaults and foreclosures is one of the key contributing factors to the current downturn in the U.S. financial markets and economy. In response, Congress passed and the President signed in July the Housing and Economic Recovery Act of 2008 and in October the Emergency Economic Stabilization Act of 2008 (EESA), which established the Office of Financial Stability (OFS) within the Department of the Treasury and authorized the Troubled Asset Relief Program (TARP). Both acts establish new authorities to preserve homeownership. In addition, the administration, independent financial regulators, and others have undertaken a number of recent efforts to preserve homeownership. GAO was asked to update its 2007 report on default and foreclosure trends for home mortgages, and describe the OFS's efforts to preserve homeownership. GAO analyzed quarterly default and foreclosure data from the Mortgage Bankers Association for the period 1979 through the second quarter of 2008 (the most recent quarter for which data were available). GAO also relied on work performed as part of its mandated review of Treasury's implementation of TARP, which included obtaining and reviewing information from Treasury, federal agencies, and other organizations (including selected banks) on home ownership preservation efforts. To access GAO's first oversight report on Treasury's implementation of TARP, see GAO-09-161 .

What GAO Found

Default and foreclosure rates for home mortgages rose sharply from the second quarter of 2005 through the second quarter of 2008, reaching a point at which more than 4 in every 100 mortgages were in the foreclosure process or were 90 or more days past due. These levels are the highest reported in the 29 years since the Mortgage Bankers Association began keeping complete records and are based on its latest available data. The subprime market, which consists of loans to borrowers who generally have blemished credit and that feature higher interest rates and fees, experienced substantially steeper increases in default and foreclosure rates than the prime or government-insured markets, accounting for over half of the overall increase. In the prime and subprime market segments, adjustable-rate mortgages experienced steeper growth in default and foreclosure rates than fixed-rate mortgages. Every state in the nation experienced growth in the rate at which loans entered the foreclosure process from the second quarter of 2005 through the second quarter of 2008. The rate rose at least 10 percent in every state over the 3-year period, but 23 states experienced an increase of 100 percent or more. Several states in the "Sun Belt" region, including Arizona, California, Florida, and Nevada, had among the highest percentage increases. OFS initially intended to purchase troubled mortgages and mortgage-related assets and use its ownership position to influence loan servicers and to achieve more aggressive mortgage modification standards. However, within two weeks of EESA's passage, Treasury determined it needed to move more quickly to stabilize financial markets and announced it would use $250 billion of TARP funds to inject capital directly into qualified financial institutions by purchasing equity. In recitals to the standard agreement with Treasury, institutions receiving capital injections state that they will work diligently under existing programs to modify the terms of residential mortgages. It remains unclear, however, how OFS and the banking regulators will monitor how these institutions are using the capital injections to advance the purposes of the act, including preserving homeownership. As part of its first TARP oversight report, GAO recommended that Treasury, among other things, work with the bank regulators to establish a systematic means for determining and reporting on whether financial institutions' activities are generally consistent with program goals. Treasury also established an Office of Homeownership Preservation within OFS that is reviewing various options for helping homeowners, such as insuring troubled mortgage-related assets or adopting programs based on the loan modification efforts of FDIC and others, but it is still working on its strategy for preserving homeownership. While Treasury and others will face a number of challenges in undertaking loan modifications, including making transparent to investors the analysis supporting the value of modification versus foreclosure, rising defaults and foreclosures on home mortgages underscore the importance of ongoing and future efforts to preserve homeownership. GAO will continue to monitor Treasury's efforts as part of its mandated TARP oversight responsibilities.