This is the second of two parts (Part 1: Prelude to HARP 3.0 as Donovan Testifies at Senate Hearing) of a summary of a hearing of the Senate Banking Committee held Tuesday during which Secretary of Housing and Urban Development (HUD) Shawn Donovan spoke on a range of housing issues but particularly on efforts to streamline and remove barriers to refinancing. In addition to addressing the issue of "fundamental fairness" for borrowers, the plan also seeks to level the playing field among servicers and originators, as well as stimulate home-price appreciation, among other things.
Jeff Merkely (D-OR) asked Donovan what it would take, a regulatory or statutory fix, to address the limit on FHA loans to a 115 percent loan-to-value (LTV) ratio. Donovan said it was actually an even lower ratio in practice but the proposal is for a broad-based refi to allow up to 140 percent with the clear view that any loan deeply underwater would have to be written down to those parameters. That, he said, along with creating a separate fund from the FHA MMI insurance fund to protect that fund would be the key legislative changes required.
Merkley asked if an insurance fee for borrowers who are refinancing would be the strategy for financing the separate fund and Donovan said another suggestion is a broad-based financial sector fee of some sort but he was also looking at a risk transfer fee as a voluntary opt-in for companies that hold these underwater mortgages. "And in laying this out over -- over 40 years, if you have basically a spread, because of the federal government guarantee funds between a 2 percent and, say, a 5 percent mortgage, and you throw in the risk transfer fee, you end up with solvency under kind of reasonably conservative assumptions. But it's not zero risk because dramatic things can happen. And that's where the federal government guarantee through FHA becomes essential, or an extension of the federal government guarantee to utilize for the Federal Home Loan Bank system."
Donovan said there is no question that by refinancing loans into FHA loans the government would be taking on some additional risk but the question is how to minimize that risk and by both focusing on current loans that meet additional underwriting criteria, lowering the cost of these already safe loans and being able to fully pay for it, they are hoping to offset any expected losses.
Most importantly, he said, there is enormous up-side potential. "If we can just move house prices a few percentage points through this broad-based refinancing, the benefits to the taxpayers through improvements in the performance of Fannie Mae and Freddie Mac, FHA, and the broader lift that the economy would have are all potentially enormous."
Donovan said there are two major changes to FHA enforcement powers they have been seeking. One is the ability to hold lenders accountable through indemnification but there are some loans and lenders for which there is no clear authority to enforce standards. The second is a somewhat perverse provision that allows FHA to go after lenders only for regional or local violations based on their track records compared to other lenders in that area. That it is not possible to disqualify an entire company nationally through current standards makes no sense.
Donovan said that there is a real urgency to get the refinancing programs on the right track because interest rates today are at the lowest level they've ever been for a 30-year mortgage. Low interest rates are typically one of the most beneficial things to boost the economy and the nation isn't seeing the full benefit of record low rates that it should be seeing. "And the quickest, most effective, and I think the most bipartisan way that we can increase the boost to the economy of these record low interest rates is to quickly get these -- these proposals enacted and -- and that's something that I think hopefully we can all agree on and move with real speed in getting these done. But as the economy continues to improve, I think all expectations are that this window of record-low interest rates may not last a significant period of time. And therefore, it is particularly urgent that we take advantage of this."
Shelby returned to the issue of second mortgages and the impact of first lien modifications on those junior liens and vice versa. Donovan said that while they have been able to insert some requirements for dealing with junior liens into HAMP guidelines and into the settlement agreement the lack of general rules for dealing with lien priority has been a problem. There are no rules, he said, except when you get to a foreclosure. No rules for what happens in a modification, especially if the second lien is current. The department has tried to get around this by putting rules in place, but it would be better to do that within the context of a universal refinancing proposal.
In answer to another question by Shelby as to the number of additional homeowners, above those participating in HARP 2.0, might be helped by the Menendez-Boxer legislation Donovan said he would have to answer as a range with Christopher Mayer estimate of 12 million at the high end. He said his department's expectations are significantly lower than that but not as low as the one million projected by some.
Even with all the benefits that would accrue to them, there are two things that are stopping some borrowers from refinancing. Some simply cannot do it - they may be above water on their first lien but have a second lien that make refinancing impossible. The second barrier is high costs - they need an appraisal or there is a monopoly in effect where their current servicer can charge them high fees, in one estimate as much as $15,000, because of the lack of competition between servicers.
Merkley underlined the urgency of taking advantage of low interest rates, recounting a program he had been involved in which was effectively killed because of rapidly escalating home prices but said to him a more critical issue is how to help homeowners who do not have GSE guaranteed loans. When he talks to constituents about their loans they generally do not know who holds it. Then he looks and finds that some are not GSE-backed and he has no help to offer them. It seems like a lottery, he said, when a family who is doing the right things can't get help simply because their loan isn't the right type. Donovan said it was correct that this is about fundamental fairness and that is one of the important issues here.
Merkley said his staff had looked at whether a fund could remain solvent and what the risks factors are and they think that the risk factors are greatest during the first few years after refinancing when a loan is still substantially underwater and the family either defaults strategically or runs into financial problems. The federal guarantee has been extended and it is the government that is picking up the losses. Maybe it is offsetting them through a risk transfer fee, insurance, or some other mechanism, but the assumptions about how to do that are critical. Then there is the question about restrictions on a homeowner in the first few years. Do you put place a rule as part of the mortgage that says you cannot walk away from this, Merkley asked, make it a legal requirement? The issue of recourse is usually determined on the state level, but has there been a discussion about rules related to recourse or whether we should have a federal overlay on this?
Merkley asked about the prospects for addressing increased risk factors inherent in the first few years after refinancing when a loan is underwater and the family defaults. Donovan effectively said that this was not the topic at hand, and that the issues mentioned by Merkley arise when a family is delinquent or where there is significant principal reduction happening. Rather, what is being discussed here are borrowers who are current, "so, we didn't see a need to go beyond that, given that these families are responsible, have been doing the right things and paying, and are not getting substantial principal reduction, at least below the 140 LTV, to -- to be able to stay".
It is appropriate in those cases to give them an incentive to be responsible in reducing their principal balance. That is why there are incentives for them to use their savings to shorten their term rather than lower their payments and thus build equity faster. "They're really giving themselves a light at the end of the tunnel that makes it less likely that they'll default in future years. And so that's something I think you're exactly right in your legislation to encourage."
On the investor side, Donovan said, there is some concern whether loans are going to be in place for a significant period of time. Investors have been generally supportive of HARP and other efforts but what they are concerned about is whether we will see a continuous cycle of refinancing. "So what we have been clear on is that once you refinance to this record low level, you're not going to see a refinance in that loan quickly. And that's a protection for investors that we do think is important in HARP and that we certainly have been open to doing in this broad-based refinancing." In other words, expect any changes to eligibility dates to be hard-fought.