Thursday, October 27, 2011

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

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