The “waterfall” means that servicers or lenders must apply proposed modification terms in a set order of succession until the borrower’s monthly mortgage payment is reduced to a target 31% DTI payment ratio. This should mean that the lender or servicer will not be required to offer a borrower an HMP modification that is any more advantageous to the borrower than what is demonstrated by the borrower’s ability to make monthly payments going forward.
The successive steps in the “waterfall” are:
Step 1: Capitalize arrearages, which include accrued interest, out-of-pocket escrow advances to third parties and any required escrow advances to third parties required during the trial period and other servicing advances.
Step 2: Adjust the interest rate to achieve a target an assumed Front-End DTI of 31%. Then, reduce the interest rate on the note in increments of .125 to get as close as possible to the Target Front-End DTI (31%), with an interest rate floor of 2%. Next, establish an interest rate cap of the lesser of the fully indexed and fully amortizing original note rate or the Freddie Mac Primary Mortgage Market Survey Rate. If the modified rate is at or above the interest rate cap, apply it to the remaining term of the loan; if not, then the modified rate is applied for the next 5 years, with an increase thereafter of 1% per year or until the interest rate cap is reached.
Step 3: If the Front-End DTI of 31% cannot be reached in Step 2, extend the term and reamortize the mortgage loan by up to 40 years from the modification effective date (i.e., the first day of the month following the end of the trial period) to achieve the 31 percent payment ratio. (Negative amortization following the effective date of the modification is prohibited.)
Step 4: If the Front-End DTI of 31% cannot be reached in Step 3, that is, after capitalization of arrearages, reduction of the interest rate to the 2.0 percent floor and extension of the amortization period to up to 40 years, the servicer must provide for principal forbearance to reduce the Front-End DTI to 31%. The principal forbearance amount will not bear interest and will result in a balloon payment fully due and payable upon the earliest of the borrower’s sale of the property or payoff or maturity of the mortgage loan. A principal write-down or principal forgiveness is prohibited on Fannie Mae loans, but permitted for non-GSE loans. According to Treasury, principal forgiveness may be used at any stage of the waterfall to achieve the target Front-End DTI, but the amount of forgiveness is not considered for Treasury’s cost share payment.
Treasury will match any reductions in monthly payments from reductions in monthly payments below an assumed Front-End DTI of 38% down to a Front-End DTI of 31% (as determined by the “waterfall”).
Lenders or servicers are required to escrow for real estate taxes and insurance and mortgage insurance premiums immediately if they have the capability of processing escrow payments or are using third-party vendors for the purpose. Lenders or servicers who do not have this capability are required to implement the process within 6 months of entering into the Program with Treasury. As a practical matter, this requirement will apply to lenders holding or servicers servicing non-GSE loans, because the GSE’s already require such capabilities for GSE-approved seller-servicers