Ask someone about refinancing a mortgage and you’ll typically hear a tale of complications, costs and paperwork. In fact, it doesn’t have to be this way. For years the federal government has refinanced FHA loans without even looking at property values with a program that has saved big money for homeowners and lowered foreclosure claims from lenders.
Broad use of the FHA “streamline” concept would instantly make millions of homeowners with toxic loans eligible for financial relief, and it would keep huge numbers of homes off the foreclosure rolls. The end result would be less downward pressure on home prices, a benefit not just to borrowers but also to their neighbors.
The 5 Percent Solution
The recently announced Obama foreclosure prevention plan has a number of standards and requirements that limit borrower participation. One of the most significant benchmarks concerns property values: You can’t get a new loan under the Obama plan if the value of your home is 5 percent lower than balance of your mortgage.
“For example,” says the Treasury Department, “if your property is worth $200,000 but you owe $210,000 or less you may qualify.”
But what if your home is worth $198,000 in this example? Nope, no relief for you.
Until the past few years, no lender would make a loan where the value of the mortgage was greater than the value of the property. There’s too much risk. Instead, lenders wanted mortgages with 20 percent up front. They would accept less, but only with mortgage guarantees in the form of insurance from the FHA, VA or private mortgage insurance companies.
What Obama is actually offering is refinancing in the absence of equity. If you’re financially underwater by 5 percent then you can still get new and better loan terms. Compared with traditional mortgage standards, this is a huge change, one which will open the refinancing process to several million financially-trapped homeowners.
The problem, though, is that the Obama program also excludes million of homeowners who are making their payments, including those who bought recently, those who bought with little or nothing down and those who bought with loans where loan balances have been increasing because of negative amortization.
Figures from the National Association of Realtors illustrate the problem. In 2008, first-time buyers usually purchased with just 4 percent down, the typical down payment for all buyers (both first time and repeat) was 9 percent, and 23 percent of all buyers purchased with nothing down.
Meanwhile, says the Association, “distressed sales — foreclosures and short sales — accounted for 45 percent of transactions in the fourth quarter, dragging down the national median existing single-family price to $180,100, which is 12.4 percent below the fourth quarter of 2007.”
The NAR data show that the typical 2008 buyer with the typical down payment saw all of his or her equity wiped out — and then some. The same is also true for many buyers who purchased in 2007, 2006, 2005, and 2004 — millions and millions of people.
Many recent buyers will not qualify for a loan modification under the Obama plan because their equity loss is greater than 5 percent. No less important, many of today’s sunken borrowers cannot be saved under the Obama plan or any plan not because they lack equity, but because they are unable to make their monthly payments.
Why are their payments so high? Because they have toxic mortgages.
In other words, millions of people would not lose their homes to foreclosure if they could refinance and lower their monthly payments. Those lower payments are unobtainable, however, because equity levels are too low.
But what if we ignored equity?
Go back to the Treasury’s example: You owe $210,000 but the property is only worth $200,000. As long as you make your payments the lender doesn’t care.
“Equity, income, credit, home values and down payments are issues when you first get a mortgage. However, once a loan is in place you don’t have to qualify over and over again,” says Jim Saccacio, chairman and CEO at RealtyTrac.com, the nation’s largest source of foreclosure listings and data. “The mortgage is a done deal. Just make your payments and lenders will never bother you whether values rise, fall or remain steady.”
The Obama plan is enormously clever, but it could be better if it was expanded to include those who simply pay their mortgage bills regardless of home values. Here’s how: Adopt the tested and tried streamline refinancing standards used by the FHA since the 1980s and lower monthly payments.
The FHA mortgage plan started during the Great Depression and has helped millions of people finance real estate. Today the FHA deal is that you can buy with 3.5 percent down, and loans for as much as $729,750 are available for the rest of the year. In exchange for the ability to buy with little down, borrowers must pay a mortgage insurance premium, generally 1.75 percent of the purchase price and 0.55 percent of the remaining loan balance in the form of monthly payments.
Once you have an FHA mortgage you have the right to get a streamline refinance. Such refinances come in two forms: If you want to increase the size of your FHA loan then you must get an appraisal. However, if you only want a rate-and-term refinance, a change in loan terms to get a lower payment, then no appraisal is required.
Get it? You don’t need an appraisal so it doesn’t matter what the house is worth. You don’t have to worry about the loan-to-value ratio because the central issue is the ability and willingness to repay.
The logic behind the FHA plan is straight-forward: If you have lower monthly costs than the likelihood of missing a payment and being foreclosed is reduced. Since the FHA is an insurance program its goal is to lower claim rates and the fastest and easiest way to do that is to make loans as affordable as possible.
The key standard for an FHA refinance is not a credit score or home value, it’s simply the willingness to make mortgage payments. If you have a solid payment record, you’re in.
The Obama plan is also an insurance program, at least in a sense. One way to hold down program costs is to have the smallest possible number of foreclosures. That’s the logic behind the 5 percent equity standard and the reason it was not 10 percent of 15 percent.
Modification Versus Refinancing
The terms “refinancing” and “modification” are often used interchangeably; however they have very different meanings.
When a property is “refinanced” it means an old loan is replaced with a new one. It also means that a new loan must be entered on the public record. If the property has two loans, the new loan will then become a new second lien. This is important because if a home must be foreclosed then the first lien must be completely repaid before any money can be used to repay the second lien.
With a “modification” there is no new loan to record on the public records. The old loan keeps its position, which means that in case of foreclosure the lender does not have increased risk.
With a modification there is no need for a new closing because there is no new loan to record. In most jurisdictions, and perhaps all, as long as the loan amount does not increase there is no requirement to record new loan documents. The savings in transfer taxes, legal fees, title insurance and settlement costs can amount to thousands of dollars when an additional closing can be avoided.
At first it may seem as though mortgage changes without a new loan are some sort of strange idea, but in fact such loans are entirely common. An ARM is an example of a mortgage where the terms are modified from time to time but there’s no need to have a new closing or a new loan every time such changes occur.
How might streamline requirements look with a foreclosure-prevention program? Drawing from the FHA program, here are some basic standards:
- The term of the new mortgage can be as long as 30 years. Merely increasing loan terms could result in lower monthly costs.
- The borrower may go from an ARM to a fixed-rate loan but not from a fixed-rate loan to an ARM. The idea should be to reduce both costs and risks.
- The new loan must result in lower monthly costs for principal and interest.
- The streamline program can be used to replace two existing mortgages with one; provided that the new mortgage is a first lien and that the total monthly cost for principal and interest for the replacement loan is less than the combined cost of the old mortgages.
- No cash, other than as much as $250, can be paid to the borrower at closing.
- The borrower must have owned the property for at least a year.
- Prepayment penalties and negative amortization for new loans are forbidden.
- Delinquent loans must be brought current to qualify for the streamline program.
- Appraisals and termite inspections are not required.
- Principal balances may not be reduced except to the extent that borrowers bring cash to closing. (In other words, mortgage investors will be paid at par for their loans.)
- Income and employment must be verified. A credit report and debt-to-income ratios must be used to show that the borrower will continue to make mortgage payments. Assets and debts must be documented.
- To prevent price gouging, the program will require HUD to announce rates, points and fees twice daily, seven days a week. Lenders will receive a set fee for their work under the program — essentially a clerical task — with no extras, ups or add-ons of any kind allowed.
“No one wants to be foreclosed,” says Saccacio. “We can save a lot of homes from foreclosure if we just use the proven and tested tools that we know can work. The FHA streamline concept if expanded is one model that could help a lot of homeowners — and a lot of lenders.”
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.