Senator Jeff Merkley (D-OR) has proposed a new, limited term program to assist underwater homeowners unable to refinance traditionally or through the Home Affordable Refinancing Program (HARP) available Freddie Mac and Fannie Mae borrowers.  The plan, which he describes in a white paper called "The 4% Mortgage: Rebuilding American Homeownership," would not require taxpayer dollars and according to Merkley, might even turn a small profit.   He estimates his plan could assist up to eight million families.

Merkley's proposal would involve setting up a Rebuilding American Homeownership (RAH) Trust which would be located within an existing federal agency; he suggests FHA, the Federal Home Loan Banks, or the Federal Reserve.  The Trust would buy mortgages meeting program standards from mortgage originators, but only for a period of three years, after which it would stop buying loans and would eventually go out of business, selling the remaining loans in its portfolio to private investors.

Three types of loans would be eligible for RAH purchase.  The first would be a 15-year 4 percent interest mortgage designed to more quickly restore a homeowner's equity.  The second would be a 30-year 5 percent mortgage, and the third would be a two-part mortgage consisting of a first mortgage equal to 95 percent of the market value of the home.  The remainder of the original mortgage balance put into a "soft second" mortgage.  The second mortgage would not accrue interest or require payments for five years, further lowering the homeowner's monthly payments.

Merkley provided a table showing how the three options would work compared to an original mortgage in the amount of $240,000.

To raise funds for the program the Trust would sell bonds.  Because the government is standing behind the bonds, the cost of capital would be equivalent to the cost of other government borrowing and the program would be largely supported by the roughly 2 percent interest spread between the cost of funds and the interest charged on the loans.  Another source of funds would be from banks and other parties that hold the current high-interest loans.  As these banks would benefit from getting these partially uncollateralized loans off of their books so Merkley envisions they would be willing to pay a risk transfer fee in return.  Alternatively Congress could assess a risk transfer fee on the entire banking sector, similar to the FDIC insurance premium.  Other sources of funds could be state funds from the Hardest Hit program or unused money from other federal foreclosure prevention programs.  The Senator says that the Trust would pay for itself and would probably generate a profit for the US Treasury. 

Borrowers would be expected to carry private mortgage insurance until the loan-to-value ratio of their new loan reached 80 percent and short sales would not be entertained except in very limited circumstances for the first four years of a loan.

As an alternative to establishing a Trust the government could guarantee the loans in the same way as is done with FHA loans.  One or the other type of government backing will be necessary at this point, Merkley said, because there is no private market for underwater mortgages. 

"Four years ago, the U.S. government acted quickly and boldly to rescue major financial institutions. However, we have not done not nearly enough for American families who are struggling with the downturn in the housing market," Merkley said.  "There are millions of Americans trapped in high-interest mortgages, and that's not just bad for them, it's bad for neighborhoods hit by foreclosures and it's a huge anchor on our economy.  A bold solution to help these families refinance is the fastest way to get our economy back on track."

Merkley's plan calls for an immediate pilot program, a step that could be taken without new legislation from Congress.