After a week that saw mortgage rates fall to new historic lows, large numbers of American homeowners remain unable to refinance their higher rate mortgages and take advantage of low rates due to acollapse in home values that has left upwards of 23% of homeowners with negative equity in their homes.
This situation of negative home equity leaves large numbers of homeowners - the majority of whom remain current on their mortgage payments I might add - feeling left behind and shut out as lenders won’t refinance their higher rate loans for fear of increased default risk.
At the same time, underwater borrowers see banks - largely at the urging of the federal government - taking extraordinary efforts to help borrowers already in default or at high risk of default. This is not say that programs like the Treasury Department’s HAMP are not appropriate or necessary, but in the absence of meaningful help for borrowers who remain current on the mortgages, the impression is created by these efforts that there is no benefit to be had for responsible behavior - and that the government and our nation’s lenders care more about borrowers in default than they do those that struggle every month to meet their financial obligations and pay their mortgages on time.
Correct or not, this apparent imbalance contributes to the overall feelings of uncertainty and skepticism that are today so prevalent in our Nation and within the housing finance industry in particular.
But there is an answer to this dilemma - as least as it relates to underwater homeowners. Our plan would require the coordinated effort of banks and the federal government. This may sound like previously proposed rapid refinance programs, but there is a twist. It works as follows:
- The program would apply only to borrowers whose mortgage rate is higher than current market rates. In other words, only when a borrower's new payment would be reduced by at least $50 per month would they qualify.
- And with one exception only - NO cash out - this program is intended as a rate reduction program. The only exception to the cash out limitation would be that borrowers with second mortgages or home equity lines of credit would be permitted under this program to pay off both loans - again as long as the total monthly payment of the new mortgage was less than the old combined total payments.
- And as for credit requirements, borrowers (owner occupied and investors alike) whose payments would be reduced qualify as long as they have been current on their mortgage(s) for at least two years. That’s it - forget credit scores, loan-to-value ratios, front-end or back-end ratios. Borrowers would qualify on the theory they if they have been current on their higher rate loans, their payment history would suggest that they will continue to pay their mortgage if their payments are reduced.
- And forget home value - again, if borrowers have demonstrated a willingness and ability to pay at higher rates - knowing that they are under water - reward them and give them an opportunity to pay less. Doing this will have the same impact to the economy as an immediate tax cut by putting money directly into the pockets of homeowners without the potentially negative impacts to the federal deficit of a tax cut.
Unfortunately the simplicity of our proposed rate reduction program will also lead to its failure in the absence of support by FHA and Ginnie Mae.
In today’s current credit environment, banks will be loathe to make loans under this program based on the limited criteria outlined above. Ignoring credit scores and home values flies in the face of the more restrictive lending standards lenders have been implementing. This is where the government comes in - offer these as FHA insured mortgage refinance loans and let lenders/issuers deliver them into a newly created class of Ginnie Mae securities - say Ginnie Mae IIIs. And don’t punish these lenders/issuers by using the performance of these loans in evaluating these lenders/issuers overall FHA/Ginnie Mae compliance. Treat these rate reduction loans separately. To do otherwise, will potentially serve as an artificial barrier to lenders leveraging this program for fear that their FHA or Ginnie Mae eligibility could be adversely impacted by the performance of these rate reduction refinance loans.
To those who would argue against this rate reduction program on the grounds that underwater borrowers represent an increased default risk, a recent study by the San Francisco Fed may suggest otherwise. In that study, the researchers concluded that "the rational default point is below the 'underwater' point where house price equals the remaining loan balance, and depends on prospects for future house price appreciation and borrower default costs (meaning impacts on credit and other such factors).”
Thus, if implemented, our rate reduction program likely will result in the tangible benefit of putting more money into the pockets of conscientious homeowners. The program could also contribute to reducing the size of the Fannie Mae and Freddie Mac portfolios on the theory that many of the current upside down mortgages are held by these institutions today and would be paid off under this program. In addition, this program will also have the important intangible benefit of making folks who today feel left behind - feel instead rewarded for their hard work and responsible behavior.