Supplemental Directive 10-05 under HAMP was just introduced by the Treasury Department on June 3rd of 2010.

This directive specifies that commencing October 1st, 2010 “servicers must evaluate any loan that is being considered for HAMP with a mark-to-market loan-to-value (MTMLTV) ratio greater than 115 percent using both the standard HAMP modification waterfall (Standard Waterfall) and an alternative modification waterfall that includes principal reduction as the required second step in the waterfall (Alternative Waterfall). When determining the loan’s unpaid principal balance (UPB), servicers should include any amounts that would be capitalized in accordance with HAMP guidelines”.

It is worth noting that servicers can already use this PRA as of June 3rd, but MUST use it as a standard practice beginning October 1st, 2010.

Servicers will be required to “reduce the UPB (unpaid principal balance) by an amount necessary to achieve either the target monthly mortgage payment ratio of 31 percent or a MTMLTV (market to market loan to value) ratio equal to 115 percent, whichever is reached first”.

If the UPB is reduced to create a MTMLTV ratio of 115 percent and the target monthly mortgage payment ratio of 31 percent has not been achieved (based on a fully amortizing principal and interest payment over the remainder of the current loan term and using the current mortgage interest rate), continue with the standard HAMP modification waterfall steps of interest rate reduction, term extension and principal forbearance, each as necessary, until the target monthly mortgage payment ratio of 31 percent is achieved.

It is very important to understand that under the original HAMP guidelines Supplemental Directive 09-01, if the NPV result for the proposed modification generated by applying the Standard Waterfall is positive, servicers must modify the loan, however if the NPV result for the proposed modification generated by applying the Alternative Waterfall is positive( under the PRA), servicers are encouraged, but are not required, to perform a HAMP loan modification utilizing PRA, even in instances where the NPV result from the Standard Waterfall is negative or is less than the NPV result generated by application of the Alternative Waterfall

Equally as important is that the Principal Reduction if and when offered, is to be treated as deferred “principal reduction program” that allows a borrower to earn principal reduction over a three-year period by successfully making payments in accordance with the modified loan terms. If the loan is modified pursuant to PRA, the principal reduction amount should be initially treated as non-interest bearing principal forbearance (PRA Forbearance Amount). The PRA Forbearance Amount is separate and exclusive of any other forbearance that may be offered in conjunction with a HAMP modification

In addition if the PRA is given on a particular case, the modification agreement language will include a notification to the borrower that principal reduction is reported to the Internal Revenue Service and may have tax consequences. The language will also advise borrowers to seek guidance from a tax professional.

View the complete Principal Reduction Alternative (Adobe PDF)

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