So You Want to Refinance?

The biggest news in housing this week was the announcement of President Obama's executive order to revamp the Making Home Affordable Program (HARP) to make mortgage refinancing more accessible to millions more Americans. Making Home Affordable has been widely criticized as a failure since the original program had targeted about 5 million potential homeowners but was actually able to refinance less than 1 million into new lower interest rate mortgages. But this week in Las Vegas, Obama announced his new fixes to HARP to make the program easier for Americans to refinance their underwater mortgages into new, lower fixed rate mortgages.

Critics of the president's executive order say that ultimately the decision to refinance these underwater mortgages will further damage the credit system by making taxpayers responsible for homes without enough equity. That is really a bogus argument because the only loans being refinanced through HARP are loans which are currently owned by Fannie and Freddie (and these are currently being supported by tax payers). Proponents say that the new program will free up consumer funds which can be pumped back into the economy to stimulate consumer spending--with some estimates at over $20 billion in funds. That, too, is bogus, for several reasons.

The first and most important reason that both the critics and proponents of the new plan are wrong is that the new and improved HARP is not going to work any better than the original. In fact, it will be plagued by many of the same problems that kept the original program from working.

The original Making Home Affordable Program allowed homeowners to refinance homes at up to 125% of their appraised value. When the new adjustments to HARP were announced, many journalists and industry experts began announcing that the new program does not utilize appraisals. That is not true. If there is not a good automated valuation model for the property, an appraisal will be required. Borrowers refinancing into fixed rate loans will not have to consider the property's value, but those refinancing into an ARM will be limited to 105% of the value of their home.

But the excitement over basically discarding property values implies that being underwater in a home is the only issue that keeps homeowners from being able to refinance when in fact there are a host of other reasons that HARP failed the first time and will fail again:

PROBLEM 1: The new Making Home Affordable Program is limited to homeowners with less than 20% equity in their mortgage. FHFA says that this program is reserved for those who "really need it." As with the original program, the current mortgage must be with either Fannie Mae or Freddie Mac and must have been originated prior to May 31, 2009. The issue here is that many Americans who have less than 20% equity in their homes have loans with private mortgage insurance on them. As FHFA's announcement states, participation in HARP is voluntary, so mortgage insurance companies and lenders voluntarily decide to participate in the program. In the original HARP program, MI companies would reissue the MI certificates on the properties only if the loan stayed with the current mortgage holder. Unless  FHFA has figured out a way to change this, that means that anyone with a mortgage with mortgage insurance whose current servicer does not participate in the new enhanced program can't refinance through HARP Phase II. And those whose servicers do participate can refinance only under the guidelines offered by their servicers.

PROBLEM 2: Many borrowers who are underwater in their homes are underwater because they have a first and a second mortgage. Under HARP, a second mortgage cannot be refinanced along with the first. That means that the second mortgage must be re-subordinated to the first mortgage in order for the borrower to be able to take advantage of the lower interest rates. And not all second mortgage holders will do that. For example, a borrower recently called me about refinancing his investment property. At the time that he purchased the home, it was his primary residence, and he had a first and a second lien. Last year, he tried to refinance through Chase, who approved him for the loan but told him that the second lien would have to be re-subordinated in order for him to close. The problem is that the second lien holder, GMAC, will not re-subordinate the second lien because the house is now an investment property and without that re-subordination, he cannot get the loan. I have seen variations on this problem several times in the last few years.

PROBLEM 3: In Texas, properties qualify under HARP for refinance but they cannot be refinanced because at one time the owners took equity loans against the houses. In Texas, our state law says that once a home has had an equity loan against it, the provision of the home equity law always apply, which means that the homeowner must always maintain 20% equity in the property. So a homeowner cannot legally refinance an underwater property with a home equity loan against it no matter what kind of program FHFA and the President develop.

Besides equity in the properties, there are many issues that have kept borrowers from refinancing over the past few years. One of the most important is income. Over the last two years, income standards have tightened incredibly. HARP does waive lender warranties to Fannie Mae and Freddie Mac, and HARP promised relaxed underwriting guidelines, but the FHFA announcement does not make clear exactly how those guidelines will be relaxed. What we do know is that the Dodd Frank bill's defense to foreclosure provisions call for all loans to have income verified fully. Borrowers whose income is improperly underwritten can use poor underwriting as a defense to foreclosure for their mortgage loan. As a result, lenders are being incredibly strict about underwriting income.

As an example, I am working on a file for a hospital employee who has been on his job for thirteen years. This man has excellent credit and has decided to refinance his home from a thirty year note to a fifteen year note. He qualifies under the current HARP guidelines. I calculated his income using his year to date income based on his pay stub and determined that he fell just under the lender's 45% debt to income ratio guideline. But when I sent in the file, the underwriter informed me that he could not qualify for a 15 year loan--he would have to refinance at 20 years. When I questioned her about the income, she said that she has a worksheet she has to use, and she calculated the income at $300.00 a month less than my calculations.

HARP has published guidelines, but lenders have their own overlays which often exceed those guidelines to make sure that they are originating quality loans. Being able to refinance is about much more than having a decent credit score or sufficient equity in your home. It is about getting the underwriter to agree that you make enough money to pay the loan back based on an ever tightening set of underwriting standards regarding income. Income qualifications have kept a lot of borrowers from qualifying to refinance under the current guidelines, and unless HARP specifically issues an income waiver--which would be completely contrary to all of the provisions of Dodd Frank--many borrowers are going to continue to find themselves locked out of an opportunity to refinance.

PROBLEM 4: While it is makes a great soundbite to go to Las Vegas and announce that borrowers will be able to refinance in the parts of the country that have been hardest hit by the economic downturns, the reality is quite a lot different. As with the current HARP program, only borrowers who currently have loans with Fannie Mae and Freddie Mac qualify to refinance under the program. That means that borrowers with exotic mortgage products such as negative amortization cannot use this new program. People who had jumbo loans--which until a few years ago was everyone financing over $417,000, do not qualify. And consumers who financed into subprime loans do not qualify. While the Fannie/Freddie portfolio does cover a lot of consumers, it also misses a lot. In the years between 2003-2008, Fannie and Freddie's market share had shrunk significantly since they could not effectively compete with many of the other products on the market. So in Arizona, California, Nevada and Florida, where many people are underwater on their mortgages, many borrowers who would qualify are in the wrong type of mortgage to be able to get the loans.

As I said at the beginning of this post, critics are saying that the enhancements to HARP will cause Fannie and Freddie to take on the responsibility of underwater mortgages.  In fact, FHFA's goal is to encourage borrowers to refinance into shorter term mortgages so that they can recover equity faster.  If the program were successful and it worked as FHFA hopes, this would in fact cause many of these mortgages to recover equity and to in fact be paid off in fifteen years.  And this is probably the basis for the billions of dollars in savings that the White House and FHFA tout that HARP Phase II will give to consumers.   As a loan originator for over thirteen years, I can tell you that the savings of going from a thirty year to a fifteen year mortgage is huge over the life of the loan--depending on the size and interest rate of the current mortgage, it can amount to hundreds of thousands of dollars.  However, the economic impact of that savings will not be felt in the general economy for fifteen years when the houses are paid off.  If consumers were to follow the FHFA's proposals to refinance their homes into shorter loans, they would actually see an increase (albeit a small one) in their monthly payments in the immediate future, which would lead to less disposable income in the short term.  Of course, if consumers stay in their homes and pay them off, fifteen years from now they will not have house payments so then they could increase their spending, but that won't help the economy now.

In the short term, this program will provide fees and income for mortgage lenders and great video opporunities for the president.  University of Virginia professor Larry Sabato told CBS this week that people need to see the President on television "trying to solve problems."  HARP II creates sound bites, but beyond that it is not going to do much more than its predecessor about changing the fate of homeowners or the current housing situation in the U.S. either for better or for worse. At the end of the day, HARP II will produce very little change and more hype than hope.

Alexandra Swann is the author of No Regrets: How Homeschooling Earned me a Master's Degree at Age Sixteen and several other books. For more information visit her website at http://www.frontier2000.net

Whose Fault is the Foreclosure Mess Anyway? Part II

In 1953 my grandmother went through a divorce at a time when very few people living in middle America got divorces.  Abandoned by her husband at about thirty years of age, she and her three young children (all under the age of 10) moved back to the tiny town of Parsons, Kansas, where her parents and siblings lived.  My grandmother moved in with her mother and father and got a job in town which barely covered the expenses for herself and and her children.  After a short time, she realized that she needed a loan from the local bank in order to make ends meet.

My grandmother did not have credit or any collateral, but she hoped that her family's long-time presence in the community would help her in securing the small loan she needed.  When she talked to the banker, she told him that her father would be willing to co-sign for her for the loan.  The banker's only question was, "Who is your father?"

"Harlan Stringer," replied my grandmother.

"In that case, I don't need a co-signer," replied the banker.  "I know your father.  If you don't pay this money back, he will, whether he co-signed for it or not."  She left the bank with the money, which she did pay back in full from her meager wages.

My great-grandparents were fairly typical of Depression-era families.  They never had any extra money, but they raised a garden and a cow which allowed them to feed their own six children plus six extra children from town every night.  (Each of their children had instructions to bring home one classmate from school each night for dinner, but to rotate the children so that all of the classmates could come out to the farm and eat.  Children who lived in town often went hungry, so it was important that the invitations be extended to everyone since the Stringers raised their own food so they always had plenty to eat.)  My great-grandfather eventually went to work for the railroad, and after he retired he stayed home and kept the garden, raised and sold chickens and fished.  At that point, my great-grandmother got a job in town where she worked until well into her seventies.

They had no expectation of wealth--no concept of winning the lottery or some contest that would bring a windfall into their lives.  They expected to work for whatever they received and to pay for whatever they owned.  They did not borrow money carelessly, because their sense of honor required that debts had to be paid--even if the debt were for an adult child who had borrowed the money because of a personal crisis but could not afford to repay the loan. 

We hear a lot of comparisons today between our present day crisis, "The Great Recession," and the "The Great Depression" but I really don't think that it is fair to compare our society with the generation from 70 years ago who weathered that storm.  The Depression-era generation was not as sophisticated as we are today and not nearly as well educated or well traveled, but they had a sense of values that our generation cannot begin to understand.

Yesterday, I said that I thought there were two seldom mentioned culprits in the foreclosure mess, and that Culprit A had helped to create Culprit B.  Culprit A, in my opinion, is the Making Home Affordable Program and all of the companion programs that play on homeowners' desires and needs and encourage them to apply for modifications they will not get.  But Culprit B is the borrowers themselves and the  "I am entitled to something for nothing" mindset that touches every facet of our society today.  No discussion of the foreclosure problem is complete without acknowledging that a big part of the problem is individuals who refuse to take responsibility for their actions.

As we listen to the media coverage of the furor over foreclosures, we hear a lot about how banks may not have fully reviewed the documents, or how the MERS system allows lenders to transfer deeds without re-recording them, but we hear very little about the fact that the average foreclosure is taking over 460 days to consummate.  We hear a lot about declining values as a reason for borrowers to practice strategic default and allow a house to be sold on a short sale, but we do not hear much about the fact that the same borrower was making the payment on the house and living in it before the home devalued.  If we discount arm resets (which can be a serious problem for homeowners who can no longer make the new higher payment), what can possibly be a good justification for stopping making a house payment just because the home devalued?  If the payment has not adjusted and there is no loss of employment or drop in income, then the borrower is making the same payment that he always was on the same house he had been living in prior to the market crash.  The equity will return at some point. 

The reason that loan modifications have been able to take advantage of so many people and put so many Americans in a position to lose their homes is that as a society, we want to be taken advantage of.  We want to believe that we should have our payment modified, we should have the principal balance we owed on the house reduced, and we really are entitled to the lowest possible interest rate whether we actually qualify for it or not.  If "life is not blowing us kisses" then we need to find someone to blame and hold responsible.  We can always hire an attorney to tell a judge that we did not understand what we were signing, or that we were tricked or misled.  And if all of that fails, we have the option of living in our home for over a year without making a house payment until the bank can finally sell it.  And we feel righteous in doing so, because after all, it is not our fault that we signed a note for something we could not afford in the first place.

Today, we do not have a point of reference for a man who valued his word so much that he would pay a bill he clearly did not owe for his daughter, particularly when paying that debt he had not signed for would have worked a genuine financial hardship on him. But his attitudes about money and personal integrity obviously influenced his own family.  My grandmother, who today is 89 years old, understood that no magician was going to come along and fix all of her problems.  In a couple of years, she met and married my mother's step father, who was in the army. She saved money carefully, and when he got out of the military they paid cash for their first home in the Kansas countryside.  After they got too old to live there, they bought a house in town which they also paid cash for. She and her new husband never made much money, but through an extremely thrifty lifestyle, she saved enough money to be comfortably self-sufficient in her old age. Her funeral arrangements are fully paid for so that even in death she will not leave behind any unpaid bills.

As a society, we will get out of "The Great Recession".  This round of foreclosures will finish and the homes will be resold.  New laws will tighten credit standards for quite a while, although experience teaches that credit standards are often cyclical and over time will tend to loosen up again.  But for our country to avoid another problem like the one we are in today, we need more than new regulations or financial reform bills, or reviews of foreclosures.  We need a return to personal integrity as individuals that demands that we repay  what we borrow, and that we borrow only what we are able to repay.

                                                                   
   

New Hope or Just More Hype?

Today the newest FHA program to refinance borrowers who owe more on their home than the property is actually worth went into effect.  This new program, made possible under the Emergency Economic Stabilization Act, will be available to homeowners starting today and lasting through December of 2012.

The impetus behind this new rule is to allow homeowners who are underwater because of dropping values to refinance into a lower interest rate so that they can better afford the payment.  The existing mortgage holder has to agree to voluntarily reduce the principal balance of the existing mortgage 10%, and then the borrower can refinance into an FHA loan up to 97.75% of the home's value.  If the borrower has a second lien, the second lien can stay in place for total loans of up to 115% of the home's value.  Notice that the principal reduction is voluntary on the part of the the current mortgage company, so if they do not agree to take a 10% write down on the loan, the borrower is out of luck. 

The program has some other interesting caveats.  For instance, it cannot be used to refinance an existing FHA loan, so if the borrower is upside down with FHA, he is still out of luck.  Also, the homeowner must be current on his house payment and must have a credit score of at least 500.  The loan may be a loan that was previously modified under Making Home Affordable but other than that it cannot have been delinquent and caught up by the servicer.  Loans that are in the HAMP trial period are not eligible for this refinance--FHA really wants to weed out dog loans on this program, so they require that you must be current on the house payment up until the month that the new refinanced loan closes.

The program also requires that other credit be acceptable.  According to HUD, major negative credit such as judgments or collections or other recent credit problems must be explained by the borrower and the explanation must be satisfactory to the lender.

HUD also wants to remind us that a short refinance in which the principal balance of the loan is reduced by 10% may negatively impact  the credit score of the borrower as it may be reported as a short refinance.  Further, the borrower should consult with a tax preparer because he may have to pay taxes on the amount of  the debt forgiveness since as far as the IRS is concerned, this could be considered income.  To put that into perspective, if you owe $400,000 on your home and you have your principal reduced 10% on your mortgage by your current lien holder, that is $40,000 in debt forgiveness which could potentially be added to your income for income tax purposes. 

HUD estimates that between 500,000 and 1,500,000 borrowers will refinance on this new program.  And that figure may be true.  What HUD is not saying is that the Making Home Affordable Program, which is the stepmother of FHA's new program, has given trial modifications to about 1.3 million borrowers so far.  The trial modifications last three or four months.  But of those 1.3 million, nearly 600,000 homeowners have dropped out of the program because they could not make their house payments, and another 250,000 are still waiting to see if they will qualify for modification.  An August 27 article in Daily Finance cites a Barclay's Bank study that 60% of homeowners who complete the Making Home Affordable Program and refinance their homes will ultimately go back into default.  The reason--they simply cannot afford the houses in the first place.

The problem is so serious that Daily Finance referred to the Making Home Affordable Program as "Real Estate Mortuary's Waiting Room," because the loans that are in HAMP are going to eventually end up in foreclosure.

HUD is hoping that the new FHA refinance will be more effective and more promising.  But with unemployment still high and sales dropping, another program to try to fix everything by lowering the house payments of homeowners who cannot afford their homes may just be a lot of hype after all.