Rising unemployment is throwing a wrench into the Obama administration’s effort to reduce foreclosures and stabilize the housing market through various initiatives like “Making Home Affordable”. When the first wave of delinquencies and foreclosures started in the fourth quarter of 2006, it was centered on the risky adjustable subprime mortgages which, in many cases, were destined to failure due to the unsuitability of the borrowers. The majority of industry watchers at the time felt that defaults would be contained to those unsuitable borrowers, with a small percentage of Alt-A mortgages at risk as well. Underestimated at the time was the effect that unemployment, resulting from the first wave of foreclosures, would have on the rest of the mortgages, including those originated for prime borrowers. According to economists, the current accelerating wave of foreclosures is directly related to unemployment or underemployment which started with the subprime mortgage meltdown and has grown to engulf the entire economy.

Also assuming that the foreclosure problems would be contained to subprime borrowers, the Obama Administration’s foreclosure prevention and loan modification plans were “built around the subprime crisis model, not the unemployment crisis model,” said Michael van Zalingen, director of homeownership services for the nonprofit Neighborhood Housing Services of Chicago.

The Obama program provides starting interest rates as low as 2% and financial incentives to mortgage-servicing companies and investors to reduce mortgage-related payments to the target of 31% of the homeowner’s monthly income. The jump in unemployment, however, has resulted in many borrowers that don’t have sufficient income to qualify for a loan modification under the plan. Mr. van Zalingen said, ” …roughly 45% of the more than 900 borrowers who sought help at two recent counseling events would fall into that category even if their interest rate were dropped to 2% and their loan term were extended to 40 years.” Many of those who couldn’t qualify had recently suffered job losses or a reduction in income, Mr. van Zalingen said. Approximately 27% of borrowers who called the mortgage industry’s national “Hope Hotline” in the second quarter of 2009 blamed unemployment as the first or second cause for their mortgage problems. That number was almost three times the amount of homeowners that cited unemployment as a major issue in the second quarter of 2008. “We recognize that unemployment is a significant complicating factor,” said Deputy Assistant Treasury Secretary Seth Wheeler. “We are studying what more we can do.” Unfortunately, it’s going to take more than study to stem the crisis.

The administration is considering making changes to the Making Home Affordable plan to address the downward spiral of unemployment and the number of homeowners that are being knocked out of the plan because of it. The administration is also contemplating whether stronger guidelines should be added to the plan concerning the way mortgage companies work with homeowners who are current unemployed but have good prospects re-employment.

One option would take the form of a forbearance plan with incentives to lenders that could be offered to good employment prospects would allow them to miss a set number of payments while they seek work. The issue here is that setting the protocol for determining good employment prospects, what kind of caps would put in place, and figuring out how many payments could be missed is a circuitous process in itself which could take years to put in place.

Other options include having the government pay a portion of unemployed homeowners’ payments, short term loans to newly unemployed homeowners, or loosening the requirements for home loan modifications in general. Nobody is claiming ownership of any of these ideas due to the complexity of getting multiple parties in agreement where some would be sacrificing more than others.

Making Home Affordable has run into multiple problems including an extremely slow rollout of the plan. Getting lenders and servicers up to speed on the plan’s guidelines while getting hit with a tidal wave of applications has led to frustration from homeowners and lenders alike. The dynamic between loan servicers and the mortgage investors behind them has also slowed matters to a crawl as they navigate issues like the recently passed safe harbor bill and the net present value test. The increasing unemployment rates and the related delinquencies comes as 20 mortgage-servicing companies are coming online with the ability to modify troubled loans under the Obama plan. While the Treasury boasts that more than 200,000 borrowers have received modification offers under the program, they recently declined to give statistics on completed loan modifications, saying they were fine tuning reporting systems. Industry watchers are saying that when home loan modifications get done they are producing positive results, particularly when legal counsel is brought in to lead the modifications for the homeowner. ‘

Meanwhile, delinquencies are rising on a monthly basis and the foreclosure backlog continues to grow. The percentage of mortgages that had gone to at least 30 days past due but not yet in foreclosure climbed to a record 8.49% in May, up from 8.08% in April and 5.66% a year earlier, according to LPS Applied Analytics. These numbers are real and growing which has homeowners hoping that the government’s planning and theoretical thinking lead to an answer sooner, rather than later.