On March 4, 2009, President Barack Obama announced a new deal that he claimed could help millions of homeowners to lower their monthly mortgage costs and avoid foreclosure.

Will the Obama plan really work? As we shall see there are both reasons for homeowners to be happy — and reasons to be dubious.

Essentially the Obama plan divides the world of mortgage borrowers into three basic groups:

• Those who are current but underwater.
  For borrowers in this category with loans owned by Fannie Mae and Freddie Mac, it will be possible to refinance even if the loan amount is marginally larger than the value of the home. For many borrowers this will mean moving from a toxic loan with high rates to a fixed-rate loan with a smaller interest cost. “Borrowers,” says the White House, “who are paying interest only, or who have a low introductory rate that will increase in the future, may not see their current payment go down if they refinance to a fixed rate.”
• Those who face foreclosure.
  The Obama Administration essentially adopts the early workout program developed by Fannie Mae. “In general,” says the White House, “you may qualify for a mortgage modification if (a) you occupy your house as your primary residence; (b) your monthly mortgage payment is greater than 31 percent of your monthly gross income; and (c) your loan is not large enough to exceed current Fannie Mae and Freddie Mac loan limits.”
• Those who are current on their loans and don't face foreclosure.
  Nope. No financial candy for you, at least directly. However, if fewer homes are foreclosed it means that home values are likely to stabilize and perhaps even rise — and that's good news for all homeowners.

How does the program really work? Let's look at some questions and answers.

Can I refinance an investment property under the Obama plan?
No.

How would the program actually work?
The Treasury Department offers this example:

“For a sample household with payments adding up to 43 percent of his monthly income, the lender would first be responsible for bringing down interest rates so that the borrower’s monthly mortgage payment is no more than 38 percent of his or her income. Next, the initiative would match further reductions in interest payments dollar-for-dollar with the lender to bring that ratio down to 31 percent. If that borrower had a $220,000 mortgage, that could mean a reduction in monthly payments by over $400. That lower interest rate must be kept in place for five years, after which it could gradually be stepped up to the conforming loan rate in place at the time of the modification. Lenders will also be able to bring down monthly payments by reducing the principal owed on the mortgage, with Treasury sharing in the costs.”
 
In effect, the Obama Administration has dumped claims by banking and mortgage lobbyists that borrowers should be required to devote 38 percent of their gross income to housing costs. Instead, the Administration is going with the standard established by Sheila Bair, chair of the Federal Deposit Insurance Corporation, who for at least a year has been arguing that the 38 percent benchmark was unworkable.

Why should a borrower make their payments when so many cheaper homes are now available?
The Obama plan has an incentive for borrowers who stick with the program.

“To provide an extra incentive for borrowers to keep paying on time,” says the government, “the initiative will provide a monthly balance reduction payment that goes straight towards reducing the principal balance of the mortgage loan. As long as a borrower stays current on his or her loan, he or she can get up to $1,000 each year for five years.”
 
If my loan is 20 percent greater than the value of the house can I still get a new loan?
No. As the White House explains “eligible loans will now include those where the new first mortgage (including any refinancing costs) will not exceed 105 percent of the current market value of the property. For example, if your property is worth $200,000 but you owe $210,000 or less you may qualify. The current value of your property will be determined after you apply to refinance.”

Will banks and servicers cooperate?
We have essentially nationalized the banking system — just look at the major banks that have recently suspended foreclosures. The banks will likely cooperate, and servicers, those who deal directly with borrowers for loan owners, will also likely cooperate, in part because there are substantial financial incentives for them in the Obama plan.

What are the potential problems with the Obama plan?
By any standard the Obama proposal is far better than anything from the federal government to date. That said, a number of concerns remain. For instance:

• Why exclude investors with single-family homes and properties with two to four units?
• If unemployment levels continue to rise there could be a large number of foreclosures even with the program.
• The majority of mortgage borrowers, those who make their payments on time and in full, may also resent the program as it does not lower their loan costs.
• Help is only available for those who are underwater a little — just 5 percent.