Throwing a Lifesaver to Underwater Borrowers

The Federal Housing Finance Agency (FHFA) released its September 2012 Refinance Report (Report) on November 28, 2012. The Report provides some statistical information, most of which comes as no surprise to mortgage industry participants, while there are some tidbits of data that seem to demonstrate the impact of the Home Affordable Refinance Program, known as HARP, on the GSEs (viz., Fannie Mae and Freddie Mac). The end date for HARP was extended until December 31, 2013 for loans originally sold to the GSEs on or before May 31, 2009.

HARP was established in 2009 to assist homeowners who are unable to access refinance due to a decline in their home value. The program was originally designed to provide these borrowers with an opportunity to refinance by permitting the transfer of existing mortgage insurance to their newly refinanced loan, or by allowing those without mortgage insurance on their previous loan to refinance without obtaining new coverage.

The premises for HARP are simply stated, as follows:

1) Since the GSEs are already responsible for certain high LTV loans; and 

2) Default risk is lowered by allowing a refinance of these high LTV loans; therefore, 

3) HARP loans refinancing high LTV loans at lower rates reduce default risk.

One of my concerns with HARP, or as it is referred to now HARP 2.0, is it has failed homeowners because it just is not reaching enough qualified borrowers and many lenders take too long to issue approvals. One remedy would be to have the government expand its guidelines to include non-agency lenders and by removing certain features of the 2009 origination qualifier. Also, low credit scores remain an obstacle by preventing underwater homeowners from taking full advantage of the current HARP guidelines with respect to refinancing eligibility.

HARP has obviously triggered a wave of refinance activity, just as expected. In speaking with several of our clients that are very involved in HARP refinances, it seems that about 50%-75% of their refinance business may be coming from homeowners who have LTVs above 125%. Because the 125% ceiling on LTV was removed, some lenders are actually refinancing LTVs of 155%.

In the following discussion, I will offer some consideration to HARP's most recent survey.*

_____________________________________________________________

IN THIS ARTICLE

Overview

HARP Refinance, Quarterly Volume

Monthly HARP Volume by LTV

Percentage of HARP Refinances by LTV

Mortgage Terms, LTVs Greater than 105%

Total HARP, Percentage of Total Refinances

Timeline for Interest Rate Changes

Library

_____________________________________________________________

Overview

-More than 90,000 homeowners refinanced their mortgage in September through HARP with more than 709,000 loans refinanced since the beginning of this year.

-Since the program’s inception in 2009, the GSEs have financed more than 1.7 million loans through HARP.

-In September, half of the loans refinanced through HARP had LTV of greater than 105% and one-fourth had LTVs greater than 125%.

-In September, 19% of HARP refinances for underwater borrowers were for shorter-term 15-year and 20-year mortgages.

-HARP refinances in September represented 45% of total refinances in states hard hit by the housing downturn - Nevada, Arizona, Florida and Georgia - compared with 21% of total refinances nationwide.

-In September, HARP refinances for borrowers with LTV ratios greater than 105% accounted for more than 70% of HARP volume in Nevada, Arizona and Florida and more than 60% of the HARP refinances in California.

________________________________________

HARP Refinance, Quarterly Volume

HARP volume continued to represent a material portion of total refinance volume in 2012 as HARP enhancements took effect in the first half of the year. HARP volume represented 24% of total refinance volume in the third quarter of 2012.

Learning to Play the HARP

A week ago the Obama Administration announced revisions to the Home Affordable Refinance Program (HARP).

Better late than never! Actually, coming three years belatedly, a change to HARP may bring some relief to homeowners and the economy.

But is it a viable solution?

As you may know, I have written extensively about the failure of both the Home Affordable Modification Program (HAMP) and HARP.

Is the new and improved version of the two-year old HARP a quick fix or yet another boondoggle in the making?

Real Estate and Jobs

Last week's announcement stems from the revisions developed by the Federal Housing Finance Agency (FHFA), the GSE's overseer, with feedback from lenders, mortgage insurers and other mortgage industry participants. In a sense the revisions are a patent admission that the economy simply will not regain its strength without a robust real estate market; or, put another way, jobs will not return unless a strengthened real estate market returns.

The linkage of real estate to jobs has roots in the MBS World, a murky realm way below the revisions contemplated by the Administration and the homeowners' needs.

The Federal Reserve has a central place in the MBS World, since it is permitted to participate in the agency MBS financial instruments, and not permitted to participate in buying equity, real estate, or corporate debt.

Remember: MBS yields are the primary trigger in the formation of mortgage rates. The safest financial instruments, of course, are Treasuries; so, relative to Treasuries, the margin or spread between mortgage rates and yields on 10-year Treasuries has continued to move upward. When the Fed makes its MBS purchase, it thereby reduces mortgage interest rates, compressing those relative margins. Operationally speaking, then, a so-called target for mortgage rates is set in this manner.

Ostensibly, lower mortgage rates lead to refinances and the concomitant diminution of financial pressure on homeowners who have been trapped in the housing crisis with underwater mortgages, because such reduction both lowers the cost of debt service through refinance and supports purchases of houses, which creates demand - and thus an increase in pricing - for housing.

What Went Wrong?

To date, a tiny percentage of seemingly eligible borrowers have refinanced through HARP.

In my estimation, these are the factors that led to the HARP failure:

-Resistance: the refusal by some second lienholders to subordinate themselves to the first mortgagee.

-Fear: the GSEs might "put back" the new loans if they subsequently move into default, which causes constrained underwriting.

-Restrictions: the original MI being applied to the new loan, particularly if the new loan has a different servicer.

-Reluctance: homeowners afraid of being rejected, lack of public awareness, and insufficient news about program information.

Also, it is common knowledge that lenders have rejected all but the most creditworthy borrowers from taking advantage of HARP, out of reluctance to take on the risk of existing representations and warranties; however, this may yet find a solution (see below).

Plans and Suggestions

In this latest version of HARP, there is an extension of the program's mandates through December 2013. As a quick overview, I think it's fair to describe HARP as a temporary program by the GSEs, the primary goal of which is to permit borrowers whose loans are currently guaranteed by the GSEs to be refinanced, despite the fact that these loans are significantly higher than 80LTV.

There are some important revisions, perhaps the most important being the removal of the 125LTV ceiling. In addition, in many cases a new appraisal is eliminated, fees to borrowers are lowered, and the GSEs are waiving some lender representations and warranties (about which we will know more by November 15, 2011, when the program guidelines are issued).

I think the revisions to representations and warranties are needed and justified, inasmuch as all loans eligible under HARP have been seasoned for more than three years, and defects in a loan usually show up in the first few years of the loan. So, the risk - and the implications for representations and warranties - is certainly much lower at this point.

As to homeowners' reluctance and lack of information, although the HARP revision does not require it, I think the GSEs should communicate with potentially eligible borrowers and let them know that their loans are eligible under HARP at current mortgage rates.

With respect to the resistance of second lienholders, many studies suggest that second liens are no longer a major barrier to refinancing. It is very important that second lienholders participate in the program, because refinancing the first lien ameliorates the condition of the second lien, due to the fact that it frees up funds that can be used for second lien servicing.

The MI issue is a thorny one. The fact is, notwithstanding the foregoing, borrowers with MI will have fewer options than others to refinance. It remains to be seen how the proposal to waive aspects of the representations and warranties will incentivize servicers to resolve the MI debacle.

A Macroeconomic Solution

So, can revamping HARP bring new jobs and stabilize the real estate market?

One study I have read, a CBO research paper, estimates that a revised HARP, structured along the lines I've outlined above, would (1) result in $428 billion additional refinancings with annual savings to households of $7.4 billion, (2) would have a small positive effect on the GSEs' net worth, and (3) would have a small net cost to the government of less than $1 billion (which, in any event, is subsumed by the Fed's prepaid MBS portfolio).

The overall effect is to create a stimulus, since HARP beneficiaries will have higher marginal means to create demand, that is, their consumption will more than offset the opposing demand from existing MBS investors (i.e., financial institutions). Based on the studies I have read, if HARP increased GDP by as little as $1 billion per year for two or three years, the additional tax revenues would significantly exceed the costs. So, the macroeconomic effect would be net positive and stimulative.

Finally, if mortgage rates were sustained by the 2% to 2.5% range that has been a trending indicator, when combined with the HARP revisions, there would be a very substantial boost of mortgage loan originations, perhaps enough of a boost to a sizeable part of the GSE portfolio. Such an impetus would mean a re-set of trillions of dollars in asset value, and a yearly reduction in household interest expenses into the many billions.

The Fed's Role

As I see it, the Fed can weigh in forcefully in supporting the HARP revisions.

For instance, if the Fed purchased as much as $2 trillion of new MBS, then existing MBS holders would be displaced into investing that $2 trillion elsewhere. Hence, such re-investment would lead to an increase in stock prices, reduction in debenture yields, increase in real estate values, and higher foreign currency values.

A recent study, conducted by the San Francisco Fed, clearly shows that Fed purchases upward of 2$ trillion would increase GDP by more than 2% in two years and create 3 million new jobs. If the HARP refinance revisions are factored in, the overall stimulative effect would be much larger, perhaps as high as creating 4 million new jobs.

Moving forward robustly with the HARP revisions would surely lead us to conclude that the new and improved version, though coming about belatedly, is not too little, too late.

What do you think?

Please feel free to comment!