Thursday, February 17, 2011

A World Without Fannie and Freddie--No Seconds For You!

As I read through the Obama Administration's Housing Plan released last week, I am amazed by how completely the plan revolutionizes every aspect of mortgage lending.  The stated goal of the proposal is to "dramatically transform the role of government in the housing market."  Government initiatives and government backed mortgages are meant to be replaced with  private market solutions from a "robust" private market.  But in fact, the new housing rules greatly restrict and constrict many of the private market solutions to housing that already exist.

One example--second liens.  Second liens are a true private market solution that lower down payments for homeowners and provide access to the equity in the borrower's home via cash loans.  The implementation of the Safe Act and required licensure for all loan originators eliminated seller financing and seller seconds on residential mortgages.  This was truly the most "private" of all private market transactions.  A seller wanting to sell his house could offer to carry a seller second, with the approval of the lender making the first lien mortgage.  If the seller's terms and conditions were accepted by the first lien lender, the seller could "carry" the second at no risk to anyone but himself.  But when the National Mortgage Licensing System was implemented, the Safe Act required that any person originating a mortgage loan be licensed.  Since a seller carrying a second lien on his own property is originating a mortgage loan, the new rule basically abolished seller financing and seller seconds.

Still, institutional second liens have remained a strong tool for financing.  And institutional second liens always represent private market options.  Most second liens are portfolioed by the lenders who offer them, so they are not sold but remain on the lender's books until the lien is refinanced or paid off.  On purchase liens, the first lien mortgage holder must be informed of the presence of a second and the terms of repayment.  But what about a homeowner who has been making his mortgage payments and wants to get a second lien equity loan or line to consolidate some debt or cover additional expenses.  Who does he ask permission from?

Until the Administration rolled out its new Housing Plan, the answer was "no one."  But that is all about to change as part of the Obama Administration's plan to phase out Fannie Mae and Freddie Mac.  "We should reduce conflicts of interests between holders of first and second mortgages and improve transparency for lenders and borrower regarding the total debt secured by a given piece of property.  Mortgage documents should require disclosure of second liens.  In addition, mortgage documents should define the process for modifying a second lien in the event that the first lien becomes delinquent.  This will prevent a second lien from standing in the way of a first lien modification and help prevent avoidable foreclosures.  Finally, we should consider options for allowing primary mortgage holders to restrict, in certain circumstances, additional debt secured by the same property."

Suppose that you own a home worth $400,000.00 which you have owned for 5 years, and because you made a large down payment when you sold your original home, you owe $300,000 on that home now.  Due to a family illness and some unexpected emergencies, you have acquired $50,000.00 in credit card debt, which you would like to pay off.  Because you have good income and an excellent credit score, your credit union will loan you the $50,000. to consolidate all of your bills at a lower interest rate with one new monthly payment that you can easily afford.  The credit union is glad to get the loan, and you are glad that you are consolidating your debt.  The only problem is that your primary mortgage holder now has to approve the transaction, and they say "no" because you will reduce the equity in the house by applying the second lien.

This represents a major shift in thinking from what we have experienced the past few years.  Up until now, the equity in a homeowner's home has been considered the owner's money.  Even in Texas, where strict home equity laws enacted in 1998 prevent a homeowner from borrowing more than 80% of the total value of the home for purposes of getting cash or consolidating bills, we recognize that the accumulated equity is really the homeowner's money. 

I understand that it is a major irritation for mortgage lenders to learn of the existence of a second lien they did not know existed.  Last summer I refinanced a nurse whose home I have financed a number of times.  She wanted to take advantage of the 15 year interest rates at 3.875%.  I financed her home when she bought it and I have handled each of several refinances.  I pulled a title commitment which was clear, and a credit report which was also clear.  Just before the loan was ready to close, I was doing final due diligence and I asked her about an inquiry from USAA on her credit report. "Oh, that's my second lien," she said confidently. "USAA gave me a loan to pay off all of my credit cards."  I stared at her in horror trying to figure out how to rework her first mortgage.  I knew that she had not deliberately withheld this information in an attempt to deceive me--she just didn't think it was worth mentioning or that it was really any of my business whether she had gotten a second lien.  Fortunately, we qualified her with the terms of her new loan and got USAA to subordinate the existing second behind the new first lien and the story had a happy ending.

But while my borrower's choice to get a second lien--and mainly her choice not to tell me about it at loan application--created a lot of extra stress for me, I never questioned whether she had a right to take out a second on her home.  She has spent tens of thousands of dollars renovating her home over the past four years, including a new kitchen, new bathrooms, new landscaping, etc.  Through her hardwork and determination she has increased the property's value greatly.  As a single mother who works as a specialized nurse she works long hours and earns an extremely good living for herself and her children.  Why should she have to ask permission to get a loan that she clearly qualifies for that will make her life easier?

A large part of what is being lost in the Housing Plan is the opportunity for people like my borrower to make their own decisions about their own property and their own money.  And while denying homeowners the right to access the credit in their home by restricting access to second liens may make life a little easier for mortgage servicers, it certainly makes life more difficult for working families who have built up equity in their homes.

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