Comparing underwater refinance plans: Ours vs. theirsby Tim Manni
The Obama Administration released another program this week design to help American homeowners. The FHA ’short refinance’ program is designed to help current borrowers who can’t refinance because they’re underwater.
Under the FHA’s program, and in order to participate, lenders must voluntarily agree to reduce the borrower’s principal by at least 10%. Once the borrower’s loan-to-value (LTV) ratio is reduced to at least 97.75%, the mortgage will be refinanced into an FHA loan.
Sounds great, right? The advantage to the borrower is obvious: they get to refinance their loan at today’s record-low mortgage rates. However, there’s only one real advantage to the lender/investor (remember this program is voluntary): the “risky” loan is removed from its books.
“It’s essentially the hopeful prevention of some future loss,” explains HSH VP Keith Gumbinger.
HUD estimates that between 500,000 and 1.5 million borrowers will refinance under this plan. “The net economic benefits will be between $11.774 and 35.322 billion.” I’m always skeptical and perplexed every time Washington puts a huge number on how many borrowers will benefit from their programs (given their track record for estimating these numbers) — it opens them up to immediate criticism (think HAMP).
Our own idea
HSH spent quite a bit of time thinking about underwater borrowers and developed our own concept to help these borrowers refinance their mortgages. We think it’s a program that is fair to homeowners, taxpayers and lenders/investors as well. It’s called the Value-Gap Refinance plan.
First a “value gap” is established by taking the original loan amount against the current value of the home. A “value gap contract” would be executed between the lender/investor and the government to cover the differential between the outstanding loan amount and the current value of the home. This amount, or payment, would not be made today, but rather deferred to the time when the property has been sold to another party.
Under this arrangement, the borrower would refinance to the present appraised value of the home. This would produce a new mortgage at a 100 percent LTV at today’s market interest rates. The homeowner would not be responsible for the difference in amounts.
Over time, natural price appreciation would serve to narrow the gap to the point where the government owes the lender or investor nothing. Any price appreciation after that belongs to the borrower when or if they decide to sell.
The entire plan can be seen here.
While no plan is perfect, there are several key aspects of ours that set it apart from the FHA’s. Instead of penalizing one party for the benefit of another, our plan is mutually beneficial and potentially more cost effective.
1) Penalizing lenders: The FHA short refi plan financially penalizes lenders, requiring them to reduce borrower principal out of their own pocket by at least 10%.
Our program never requires lenders to put up their own money, or collect funds on anything less than the original loan amount.
2) You might still be underwater: Even after an FHA short refi, the borrower could still be underwater. If you have a second mortgage and the second lien holder doesn’t agree to extinguish the entire second mortgage, you could still be allowed to refi to an FHA loan with a total LTV of up to 115%. That puts you and the FHA at risk.
3) Lower credit score: Under the FHA plan, a borrower’s credit score could be negatively affected:
Mortgagees must make borrowers aware that, as with any loan forgiveness action, the short refinancing under this program may be reflected as a negative feature on a borrower’s credit score.
Our program wouldn’t lower a borrower’s credit score because the lender is never collecting less than the original loan amount, thus has no reason to report a deficiency to any credit bureau.
4) Government costs: Unlike the FHA plan, our plan is designed so that the government’s costs decline over time:
As time goes on, and home prices eventually recover, the amount of the value gap contract would diminish. This change of the contract value amount would happen at the time an appraisal was conducted in preparation for the home to be sold to another party.
HUD explains that any loss associated with loans that have been refinanced into the FHA (but subsequently fail) will be shared by the FHA and funds from the Emergency Economic Stabilization Act of 2008.
Which plan makes more sense?
We’ll let you be the judge of that. We really encourage you to read our Value-Gap Refinance plan in full and let us know what you think.