October 4th, 2011

Here’s why the FHA Short Refinance program isn’t working

by Peter Miller


4-FHA-logoIn recent weeks, there has been some speculation of an enhanced federal refinance program that targets underwater borrowers.

However, this “enhanced” version of HARP won’t be the first of its kind. A refinance program which focuses on underwater borrowers already exists.

Like many of the federal home preservation efforts in effect today, the FHA’s Short Refinance plan has too fallen short of its goals.

How many borrowers have been refinanced?

The FHA Short Refinance program for underwater borrowers was first announced last August. At this point, we’ve had over a year now to look at the results:

In a one-year period there have been just 891 applications and 305 originations under the program.

How come the FHA program has gained so little traction?

According to former FHA Commissioner David H. Stevens:

“We’re throwing a life line out to those families who are current on their mortgage and are experiencing financial hardships because property values in their community have declined,” said FHA Commissioner David H. Stevens last year. “This is another tool to help overcome the negative equity problem facing many responsible homeowners who are looking to refinance into a safer, more secure mortgage product.”

Which loans qualify?

Under the FHA Short Refinance program, an underwater borrower could qualify for a new loan under several conditions:

  • The loan has to be current
  • The property has to be owner-occupied, with one to four units
  • The existing loan cannot be an FHA mortgage
  • The lender of the existing loan has to agree to a 10 percent principal reduction
  • The refinanced FHA-insured first mortgage must have a loan-to-value ratio of no more than 97.75 percent.

In other words, this loan is designed for a borrower with good credit, who has been making monthly payments on time but cannot get a lower mortgage rate because they are underwater (they owe more on their mortgage than their home is worth).

Lenders don’t like the program

Under the short-refinance plan it’s the lender who is expected to pay by reducing the size of the debt.

Lenders, of course, think such an arrangement stinks–the very reason so few have agreed to the program.

Moreover, the loss will likely be a lot more than 10 percent.

Borrowers just want a chance to refi

You can understand that from the borrower’s point of view the financial situation seems unfair because all payments are being made on time and their monthly costs could be far lower, only if they could refinance.

Who will pay for the property’s loss of value?

Imagine that a home was purchased for $500,000 with 5 percent down. The original loan amount was $475,000. After five years the value of the property today is $425,000. If the property is refinanced for 97.75 percent of the current fair market value, the new mortgage amount will be $415,437.

From the lender’s perspective the current loan is fine.

Mortgage rates were higher when the loan was issued as compared to today. The borrower is making payments, so the lender has no reason to prefer a refinance to a lower rate and certainly no reason to want a new and lower principal debt.

The real problem

The real problem with the short refinance program is that it foretells just how difficult it will be to refinance the millions of home loans which could benefit from refinancing to a lower mortgage rate.

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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