Up to now, the administration hasn't had a very successful program to help homeowners. Will its latest attempt fare any better?
A few years ago, the Obama administration unveiled an effort to refinance millions of mortgages owned or guaranteed by Fannie Mae and Freddie Mac. It didn't work out so well. After two-and-a-half years, the program accounts for less than a million mortgages refinanced. As a part of the White House effort to stimulate the weak economy, the president hopes to fix this program. Due to a couple of key changes, it may work better now.
What's New This Time?
So what's different now compared to 2009? Now the effort has more parties on board who have agreed to expand its reach. In particular, the Federal Housing Finance Agency, the regulator responsible for housing finance giants Fannie Mae and Freddie Mac, has agreed to loosen a number of requirements. Let's look at some of the key problems and solutions.
Problem: Underwater and slightly-above-water borrowers are not eligible.
Solution: Provide refinancing regardless of equity levels
This is arguably most significant change. For borrowers whose mortgage is owned or guaranteed by Fannie and Freddie, the FHFA will ignore how much (or how little) equity they have in their home when they apply for refinancing. So even if a family's mortgage balance is much larger than the value of its home, it could still qualify for refinancing if other conditions are met. This is a big deal. In the past, borrowers' loans could not exceed 80% of the value of their home, at most.
In a period after home prices fell dramatically, this criterion severely limited the population who could refinance. Now millions of underwater or slightly above water Americans may be eligible for refinancing. This applies to borrowers who have fixed-rate mortgages. An loan-to-value ceiling of 105% still applies to borrowers with adjustable-rate mortgages.
Problem: Refinancing fees are too expensive for some borrowers.
Solution: Eliminate or reduce fees significantly
Fannie and Freddie ("F&F")have agreed to eliminate certain risk-based fees for borrowers who refinance into shorter-term mortgages (like a 20-year mortgage instead of a 30-year). For other borrowers, the fees will be reduced. With the big front-end cost of refinancing reduced, borrowers will be able to more easily afford it.
Problem: Appraisals add delays and additional costs.
Solution: Allow process to rely on "automated valuation model" appraisals when available
Currently, F&F use an automated valuation model to estimate property values. Now it will rely on this method for all refinancing through this program, instead of bothering with 3rd party appraisals. This will cut costs for refinancing and make the process less cumbersome. Since the value of the home relative to the loan size isn't contingent on refinancing anymore anyway, obtaining one or more carefully performed appraisals isn't necessary.
Problem: Mortgages sold to F&F are subject to representations and warranties that make banks nervous about refinancing.
Solution: Waive those reps and warrants
In this case, lenders are being provided cover for refinancing. When lenders provide a mortgage, they make certain reps and warrants to F&F about the quality of the loan. If the mortgage is refinanced, the lender could retain some liability due to the quality of the loan. F&F has decided to waive certain reps and warranties if lenders commit to refinancing. This would help to protect lenders if these refinanced loans eventually go bad.
Problem: Second liens in place complicate refinancing the first mortgage.
Solution: Automatically re-subordinate second liens after refinancing
This one is a little complicated but very important. Many homeowners have second liens on their mortgage, like from a home equity loan. When a refinancing occurs, the old mortgage contract is wiped out and a new one is created. But if a second lien is in place, then it should take place ahead of that new mortgage. Since no lender wants their new mortgage to have only second priority, they might not want to allow a new refinancing. FHFA says that "all of the major lenders" have agreed to automatically re-subordinate their second liens after refinancing under the Treasury's program.
Problem: Providing millions of refinancing actions is hard to do in a short period of time
Solution: Extend the timeline of the program out very far
This program officially begins on November 15th and will be in effect through the end of 2013. Two years should be plenty of time for eligible borrowers to take advantage.
Why These Changes Matter
The administration appears to have accounted for all of the major obstacles to refinancing and eliminated them. A home's value no longer matters. The cost should be less prohibitive to borrowers. Much legal red tape has been cut. Other loans tied to the home won't stand in the way. Ample time to refinance is provided. This should help to allow at least a million Americans to refinance who haven't had the opportunity to do so in the past.
If this works as hoped, then those consumers will have more money in their pockets each month. Borrowers who see their mortgage interest rates drop from 5% or 6% to near 4% will often have a few hundred dollars more per month to spend or save. If they spend that money, then it will stimulate the economy and create jobs. If they save it or pay down their current debt, then their personal balance sheets will be healthier sooner and their spending will rise sooner than it would have otherwise. The effort may even prevent some strategic defaults, as underwater borrowers won't feel as bad about their mortgages if their payment is reduced significantly.