Most mortgage watchers are keenly aware that 30-year mortgage rates are once again sinking, and are now hovering around around 5%. However, few are aware that 15-year rates have been falling even faster. According to the most recent Freddie Mac Primary Mortgage Market Survey, the average 15-year mortgage rate is only 4.46%, just above the record low 4.33% recorded in early October. Only 6 months ago, the spread between 15-year and 30-year rates was .3%. Now it’s .6%. Over that time period, 30-year rates have risen, while 15-year rates have fallen. Unsurprisingly,demand for 15-year mortgages is now outpacing demand for the 30-year alternative.

While it’s impossible to offer a comprehensive explanation for this divergence, most analysts attribute it to the fact that the different mortgages are being utilized by different types of borrowers. “The main users of 15-year loans…are established homeowners refinancing mortgages — people secure enough that they often take on larger monthly payments in order to pay off their loans before they retire…People who take out 30-year loans, by contrast, are generally less well established, with smaller down payments, and require a bigger slice of their incomes to make their payments.” Given the current economic climate, then, it makes sense that lenders are willing to offer a discount to those with an established credit history (i.e. 15-year borrowers), compared to those entering the market for the first time (i.e. 30-year borrowers).

As for those of you trying to decide which duration is most appropriate for you, well, that’s not an easy question to answer. In a nutshell, a 15-year mortgage will save you a tremendous amount of interest (more than half) over the life of the mortgage, but this is offset by a much higher monthly payment. There is also a psychological benefit of being able to pay off the mortgage sooner and not have to worry about spending the rest of one’s life making payments. Summarizes a Freddie Mac rep: “The thinking is that many baby boom mortgagors are taking advantage of the low rates to refi into a mortgage that will enable them to live a relatively care-free retirement life — i.e. free and clear of mortgage debt.”

But with any dilemma, the reality is much more nuanced. For one thing, the monthly payment associated with a 15-year mortgage is significantly higher. Accordingly, one might opt for a 30-year mortgage and simply repay it in accordance with a 15-year amortization schedule. In this way, one retains the flexibility to make the lower (30-year) payment if financial hardship strikes. This “insurance” is inexpensive relative to the overall mortgage, adding $50 a month for a $200,000 mortgage. Skeptics counter that few borrowers are disciplined enough to make the 15-year payment voluntarily and that for those facing financial hardship, making a 30-year mortgage payment will probably be just as problematic as a 15-year payment.

Other proponents of 30-year mortgages point to the extra interest as an advantage, since it is tax-deductible. One clever analyst thought he had figured out a way to save money overall with a 30-year mortgage by exploiting this loophole, but it turns out that the spread between 15-year and 30-year rates has widened to such an extent that “the math no longer works.” Once again, the skeptics rightfully point out that even if you can deduct 30% (assuming a relatively high tax bracket) of your mortgage interest, that still leaves 70% that you are paying to the lender.

Finally, there is also the possibility that interest rates will skyrocket, creating a possible arbitrage opportunity with a 30-year mortgage that wouldn’t exist with a 15-year mortgage. Basically, if you invest the funds that would otherwise have been paid to the lender in a high-yield savings account, you would end up with more money than you would otherwise have had if you simply opted for the 15-year mortgage. But these opportunities are pretty rare, and anyone who argues to the contrary is probably trying to cover up the risk associated with such a strategy.

In short, it’s reasonable to assume that a 15-year mortgage will save you money, compared to a 30-year mortgage. However, the higher monthly payment is an important consideration, and should not be accepted by those with uncertain financial situations. If, on the other hand, your income stream is relatively stable, and you’re eager to escape from under the burden of debt as quickly as possible, the 15-year mortgage is a reasonable choice.

By all accounts and measures, the foreclosure crisis continues to rage. “Foreclosure filings were reported on 937,840 homes in the three-month period, a 23 percent jump from a year earlier, according to a report real estate firm RealtyTrac.” For many industry analysts, this has come as a complete surprise, as it was expected that the government’s loan modification program would have contributed to an (temporary) abatement. That’s not to say that the efforts of the Obama administration have been in vein; rather, it speaks to a change in the underlying dynamics of foreclosure.

In short, the crisis has entered a new phase. Initially, the majority of foreclosures were driven largely by sub-prime and other risky types of loans. As interest rates rose and housing values plummeted, many of these borrowers suddenly found themselves unable to afford the higher payments and defaulted on their loans. At this stage, foreclosures were largely concentrated in bubble regions of the country, where house prices had appreciated faster than justified by fundamentals. This type of foreclosure has been easy to address, although not as easy to prevent. With the support of lenders, the federal government has sought to modify the mortgages for those struggling with higher debt burden. The underlying principle was pretty straightforward: lower payments should translate into lower default rates.

In the still-emerging second stage, foreclosures have begun to crop up among prime borrowers in relative stable housing markets. This trend is unrelated to risky lending practices, but instead, is a product of the economic downturn and rising unemployment. Job losses have exposed the precariousness of many borrowers’ finances, causing them to begin missing payments almost immediately thereafter. As a result, “About 30% of foreclosures in June involved homes in the top third of local housing values, up from 16% when the foreclosure crisis began three years ago…The bottom one-third of housing markets, by home value, now account for 35% of foreclosures, down from 55% in 2006.”

This brand of foreclosure, while easy to identify, is nearly impossible to treat directly. In many cases, unemployed borrowers can’t afford to make any mortgage payment, which means a loan modification wouldn’t do much to ease the possibility of default. The government is facilitating refinancings for mortgages with negative equity, but for most borrowers, this will only forestall the inevitable. Only when the economy recovers and employers begin hiring again will the crisis subside. While the Mortgage Bankers Association (MBA) is projecting that unemployment will peak at 10% in 2010, many analysts expect that the total number of foreclosures will be roughly the same as in 2009.

Even if new foreclosure filings subside, however, there is still an enormous “shadow inventory” of foreclosed properties that hasn’t yet been brought to market. According to a recent report by Amherst Securities Group, “As many as 7 million pending foreclosures could flood the market in the near future, driving housing prices down. That number represents homes that have already been repossessed by lenders or are in serious danger of defaulting….The 7 million units represent 135 percent worth of an entire year of existing home sales, which are pegged at 5.2 million.” Lenders realize that the housing market is still tenuous to try offload more than a small portion of these properties.
“But some economists expect that a wave of foreclosed properties could hit the market in 2010, dampening home prices again,” as self-imposed moratoriums are canceled.

Many homebuyers smell opportunity, and have waded cautiously into the market. The same goes for speculators, some of which are buying foreclosed properties en masse. Others are buying mortgage notes at deep discounts, as part of a gamble that borrowers will be able to repay them after the crisis eases. “The process works like this: A company or its investors purchase a note, then the homeowners get a knock on their door and are given the news about the change of their loan servicer and offered a modification.” As always, these first-movers could potentially reap large windfalls, Still, given that foreclosures have yet to peak, it might be wise to remain on the sidelines, until all of the dust settles.

According to the most recent data, more than 25% of mortgages are underwater- that is, the balance owed on the mortgage exceeds the value of the home. In the most troubled areas – such as Florida, Nevada, California, and Arizona – this figure can exceed 75%. In addition, negative equity positions can be sizable; one survey showed that the average Miami resident with an underwater mortgage owes about $75,000 more than the value of his mortgage.

In light of these statistics, it’s not surprising that more and more borrowers are simply walking away from their mortgages, despite the fact that many have the financial wherewithal to continue making payments. According to Experian, a credit rating agency, 582,000 such borrowers executed a “strategic foreclosure” in 2008 alone, which is more than twice as high as the 2007 total.

In other words, a growing contingent of borrowers has determined that it’s simply not economical to continue paying their mortgages. (As an aside, this is an excellent indication that homeowners, themselves, don’t have much confidence in the apparent housing recovery that many analysts believe is taking shape). Before, it was assumed that the impact of foreclosure on one’s credit would be enough to discourage strategic default, but the uptick in this trend demonstrates otherwise. Some borrowers evidently think it will be too many years before housing prices will return to the bubble levels. For those that bought properties for speculative purposes, there is a sense that it makes little sense to continue making payments on an investment that has little value.

Despite the clearly negative impact of this phenomenon for lenders, they appear to be doing little to avert it. Some are finally helping borrowers with loan modifications, but this rarely involves a truncation of the principal amount. Thus, borrowers who were underwater before receiving a modification will likely remain underwater after a modification, despite the lower monthly payment.

The government, for its part, hasn’t done much either. Its program aimed at helping underwater borrowers reduce their debt burdens through refinancing has been a miserable failure, reaching only 3% of eligible borrowers, despite the recent elimination of an initial 5% cap on underwater equity. It seems that despite the possibility of a lower interest rates, most borrowers are smart enough to realize that paying money (i.e. closing costs associated with the refinancing) to retain an underwater mortgage doesn’t make financial sense. Ironically, the Mortgage Forgiveness Debt Relief Act of 2007 is facilitating strategic default by allowing borrowers to discharge of debt tax-free. [If not for the law's passage, foreclosure could have potential tax consequences].

Still, there are negative consequences of ignoring government help and deliberately defaulting on a mortgage. For the majority of Americans, foreclosure is still stigmatized. From a financial standpoint, foreclosure (as well as short sales and deeds in lieu of foreclosure) will immediately result in a lower credit rating, diminished ability to borrow, and higher interest rates. Thanks to the Mortgage Forgiveness Debt Relief Act, strategic default no longer carries any tax implications. Of course, they may be costs associated with finding a new residence.

From a legal perspective, one’s liability post-foreclosure depends one’s state of residence. 10 states forbid banks from making claims against personal assets when foreclosing on a mortgage with negative equity. The other states, however, generally allow lenders to sue for the difference. Legal experts have indicated, however, that this is only used in 15% of cases, which means the majority of defaulters get off with hardly a slap on the wrist. Still, if you’re considering this as an option, it would be beneficial to consult a lawyer and/or accountant just to confirm.

As part of our continuing series, today we bring you an interview with John M. of Housing Doom, who despite not yet having achieved macroeconomic enlightenment, was one of the first bloggers to spot the housing bubble, and comment on the impossibility of getting “something for nothing.” Enjoy!

Read the rest of this entry »

If used properly, mortgage assumption can provide valuable benefits for both the buyer and the seller. If used improperly, however, they can be a bane for both parties, as well as illegal.

Let’s start with the basics: What is meant by the term “assumed mortgage?” In a nutshell, the assumption of a mortgage is just what it sounds like- the transfer of all liabilities associated with a mortgage from one party to another. There are several variations, but it basically refers to a situation in which the buyer of a home assumes the existing mortgage from the seller, in lieu of taking out a new mortgage.

The benefit of such an arrangement is cost savings. Especially if interest rates have risen in the interim (i.e. in the time that has elapsed since the mortgage was initially obtained), the savings can be significant. Even with significant changes in interest rates, there are savings associated with not having to pay closing costs associated with obtaining a new mortgage. A buyer whose credit is less than stellar meanwhile, can avoid negotiating with a bank, and instead negotiate directly with the seller. Typically, any savings are shared between the buyer in the seller, and are simply tacked on to the price of the home.

Historically, mortgage assumption was only ever popular during times of interest rate uncertainty, namely the 1980’s and early 1990’s. At that time, many mortgages were assumed privately. In other words, the transfer was negotiated directly between buyer and seller, without the knowledge of the lender. Such mortgages are often structured as wraparounds, whereby the original mortgage is maintained by the original borrower, who receives payment from a new homeowner at a spread to the original borrower. Nowadays, such assumptions have become the exception, since lenders have caught on and inserted due-on-sale clauses into mortgages, which essentially required them to be repaid in the event of a change of ownership on the underlying property. Failure to notify the lender of a mortgage assumption, in such a case, qualifies as mortgage fraud.

Some lenders have become more amenable to mortgage assumption, such that they are willing to honor a transfer to a new borrower without assessing fresh closing costs. The catch is that in the process, the interest rate is ratcheted up to conform with prevailing rates. [Otherwise, the lender would deprive itself of the income that it could earn from charging a higher rate]. It should be noted that FHA and VA loans are always assumable, although those originated after 1989 require the approval (and payment of certain fees) of the lender.

If private mortgage assumption strikes you as incredibly risky, that’s because it is! While a public (i.e. lender-approved) assumption relieves the original borrower of all liability, private mortgages are off-the-record (and often illegal) and hence must be resolves directly between the two parties involved. Failure by the new borrower to make timely payments would place the original mortgager in the awkward position of playing landlord, perhaps to the point of executing a form of foreclosure. Meanwhile, mortgages that are assumed multiple times still leave the borrower (and his credit rating) on the hook until for as long as the mortgage remains existence, as one borrower learned the hard way.

In today’s ultra-strict lending environment, chances are you won’t ever have to deal with mortgage assumption. Given that rates are projected to begin rising, however, it could conceivably experience a modest surge in popularity. Still, for the average borrower, it’s not something worth considering.

The trend of mortgage rates over the last couple months has generally been down, or at worst flat. That could be about to change, however, as rates ticked up for the first time since August, averaging 5% on the dot. According to an alternative survey conducted by the Mortgage Bankers Association (MBA), the rate for the benchmark 30-year fixed-rate mortgage surpassed 5% two weeks ago and is in fact now closer to 5.1%

Meanwhile, the average rate on a 15-year fixed-rate mortgage rose to 4.43 percent, from 4.37 percent last week, according to Freddie Mac. Rates on five-year, adjustable-rate mortgages averaged 4.4 percent, up from 4.38 percent a week earlier. Rates on one-year, adjustable-rate mortgages inched down to 4.54 percent from 4.6 percent. Points across all four categories of mortgages have remained constant at around .6.

Regardless of which survey you prefer, they all indicate that rates are rising. The consensus among analysts and industry insiders, meanwhile, is that they will continue to rise. “At a congressional hearing on Tuesday, MBA Chief Economist Jay Brinkmann said that the ‘most benign estimates are for increases in the range of 20 to 30 basis points’ but that some estimates of potential increases ‘are several times those amounts.’ ” The main reason for the projected increase has nothing to do with changes in the balance between the supply and demand for mortgages. Rather, it is grounded in the expectation that the Fed is planning to turn off the spigot of cash that has already spewed more than $1 Trillion into the market.

Typically, an inverse relationship exists between mortgage rates and home prices, such that when rates rise, prices fall. This is primarily due to the fact that borrowers work backwards when buying a home by first determining the highest monthly payment they can afford. With higher rates, the interest portion of the payment rises at the expense of the equity payment, which translates into a decline in the price of a home one can afford.

It is not clear whether that relationship will hold this time around, if/when mortgage rates finally rise. Home prices have actually ticked up over the last two quarters, and it’s possible that this momentum will be sustained. Unfortunately, this is not the view espoused by the majority of analysts. Robert Shiller, of the eponymous Case-Shiller Index, has discerned through a recent survey that a bubble-mentality has gripped many of the buyers wading back into the market. Anecdotal evidence also suggests that speculators have returned to the markets, en masse.

First-time buyers make up the other large contingent. When the tax rebate underlying such sales expires this month, chances are that this class of buyers will disappear completely. Even if Congress extends the deadline of the program, it’s likely that it won’t have much of an effect, since most of the determined buyers have already entered the market. Investors have already come to understand this notion, which explains why housing stocks are down nearly 20% from the summer highs.

“I’m a firm prophet of the ‘W’ shaped recovery. Housing is going to go down again in the first quarter of 2010. The real healing won’t begin until all these nonperforming loans start trading in earnest, until we get these borrowers back on their feet,” expounded one analyst. In other words, housing prices can’t recover until the economy recovers. Put another way, the housing market won’t return to normalcy until the financial situations of long-term, non-speculative borrowers have likewise returned to normal.

As part of a new series, the Mortgage Calculator will begin interviewing other housing columnists/bloggers. The following is our first interview, with Patrick Killelea of Patrick.Net, one of the most widely read blogs on the housing crash.

Despite his vast readership, “Patrick has no background in real estate at all. He is the author of the O’Reilly book Web Performance Tuning. He lives in Menlo Park, CA.” In his own words, “You should not believe anything he says until you understand the math yourself. Here’s the math:

• 3% annual cost of renting is less than the 9% annual cost of owning the same thing

If you understand that, then you probably understand the rest of this [my] site as well. If your job depends on not understanding that, then you won’t understand it.”

Mortgage Calculator: Given the sub-title of your blog, is it fair to say that you believe the housing market hasn’t yet bottomed?

Yes, I think the housing market has much further to fall on the coasts and in expensive areas. But in some poor neighborhoods, prices have fallen back into line with rents already, meaning that it’s about the same to rent or buy there. So those poor areas seem close to a bottom.

Mortgage Calculator: You write that when interest rates rise, housing prices generally fall. How do you square this with the notion that interest rates will probably rise when there is evidence of an economic recovery, at which point borrowers will be in better positions for buy expensive homes?

Prices on the coasts are so far beyond the range of the median salary that any small increase in salary is insignificant compared to small increases in interest rates. It is still common for borrowers in California to have ten times their annual income in debt. They can pay their mortgage only at extraordinarily low adjustable interest rates, and only until the mortgage resets. A reset from 4% to 6% means 50% more interest every month.

Mortgage Calculator: Do you think, then, that when the Fed finally raises rates, that home prices will start to once again fall?

Start once again? Not sure what you mean there, since prices are still falling right now. For a realistic view, avoid all news which quotes used-house salesmen (realtors) because they will say anything that parts fools from money.

But yes, rising rates will definitely push prices down even more.

Mortgage Calculator: Given the lopsided relationship between housing prices and rental rates, do you that it makes sense for real estate investors to look at buying rental properties?

Only in poor neighborhoods, so far. You can easily calculate the annual rent to purchase price ratio and see what kind of gross return you can expect as a percentage. Returns in wealthy areas are too low to justify the high prices, about 3%, but there are poor parts of Oakland, for example, where the return is over 10%.

Mortgage Calculator: On a related note, do you generally believe that renting is more economical than buying, even when the ratio of rent to home prices is more in line with long-term averages?

No, if you think about it for a minute, you see that renting must have been more expensive historically than owning, or landlords would have gone out of business. If their mortgage and expenses are $2000 per month, but the tenant is paying $1500 per month in rent, the landlord is losing money.

The basic theme of my site is that that relationship is inverted now, and landlords in middle-class and better areas are giving a huge gift to renters. It’s a fantastic time to be a renter. You get the use of a house for free, paying only the property tax and maintenance.

Mortgage Calculator: You pointed to appraisers as facilitating the rise in housing prices, because of the way they are incentivized. Recently, there have been reports that appraisers are dragging their heals in the opposite direction, wary of fomenting another bubble in housing? Do you think these reports tell the story? How do you think this will changed as a result of the new laws which require appraisers be appointed directly by the lenders?

No, I think all those stories about appraisers dragging their heels are just the used-house salesmen complaining that appraiser honesty is putting a damper on their business. The business of realtors is deception. Honesty doesn’t sell houses.

But I have little faith in those laws. There is so much money to be made by fleecing buyers that realtors will find ways to eliminate the honest appraisers. The NAR (National Association of Realtors) is one of the biggest lobbyists in DC, and lobbyists literally write the laws and hand them to congressmen these days. The NAR will find a way to defeat honest appraisals unless we have sweeping campaign finance reform.

Mortgage Calculator: Many analysts have argued that the apparent stabilization in the housing market is being supported by a glut of first-time buyers, driven by the government’s $8,000 incentive plan. You wrote recently, however, that there is “Shortage of first-time buyers.” Can you explain?

Everyone who could afford a house already bought one. And then people who could not afford a house bought one too. And then the builders kept on building. New people do come into the market, but compared to the saturation level, there are just not that many first-time buyers. No glut.

The $8,000 tax incentive did nothing but keep prices $8,000 higher than the market would have set. Those who bought with that incentive actually got no benefit. The real solution to help buyers is the lower prices that the market would set based on rents and salaries. But that harms banks, and banks are also big lobbyists in DC. So the incentive was an $8,000 per-sale gift to banks, not to common people. So again, corporate control of government is being used to part people and their money. Campaign finance reform would help.

Mortgage Calculator: What do you think it will take for people to accept the notion that home prices don’t appreciate much faster than the rate of inflation, over a long-term period of time?

They have to grow up seeing that fact in front of them every day. The Japanese now have seen 15 years of continuous residential real estate declines. I imagine the psychology is finally changing there.

It would also help if there were an open market in real estate, where every bid had to be validated by a bank, and published in the papers. Realtors lie about bidding wars all the time, but because bids are not public, they get away with it.

Mortgage Calculator: How would you reconcile government and seller incentives and low interest rates with the possibility that home prices could fall further, when advising someone thinking about buying their first home? Would you advise them to buy, wait for a while, or wait forever?

Rather than look at macroeconomics, I would say they should look at two aspects of their own situation:

1. Rent for a comparable place
2. Their salary

They should wait if renting is cheaper than owning at a 30-year fixed mortgage rate. And they should wait if the debt they are thinking of taking on is more than 3 times their salary in a secure job.

If rent would be significantly more than owning that same thing, then it makes sense to buy. Also, if someone has the cash on hand, or if they have a much larger secure income than is needed to service the expenses, then it’s also OK to buy if they plan to stay there a long time.

The entire goal is not to waste life as a debt-slave. But it takes independent thought and determination to avoid that fate.

Loan modifications have been a popular theme on the Mortgage Calculator blog for the last couple weeks, and I plan to continue in that vein with this post. I’ve already covered the process of having a “private” loan modified (one originated/owned by a private lender). Today, I’d like to overview the process for having a “public” loan modified.

First of all, let me explain what I mean by a public loan. I’m primarily referring to loans guaranteed by the Federal Housing Administration (FHA). These loans have historically been available to low-income borrowers, who can apply for a mortgage through the FHA to achieve down-payment assistance and or more affordable mortgages. The second category of “public”mortgages are those held by Fannie Mae and Freddie Mac. These mortgages have always enjoyed an implicit government guarantee. Since the government effectively took control of the mortgage giants, you could say that it has a vested interest in ensuring their solvency, at the very least.

Those that have FHA mortgages are perhaps in the best position when it comes to loan modification. Eligible borrowers typically enjoy a 30% reduction on the interest-accruing balance on their respective mortgages. For as long as they live in the home and stay current on the original mortgage, they are only required to pay interest on the other 70%. When borrowers move out or refinance, however, the entire balance comes due.

Of course, FHA borrowers still have to jump through the same hoops as normal borrowers in order to achieve a modification. In other words, it’s not the FHA that ultimately has the power to approve/deny a modification request, but rather the loan services, which are incentivized by the government to support the program. Still, borrowers who are not yet delinquent on their mortgages probably don’t have a shot of getting approved, and the same is true for borrowers whose financial situations are especially desperate. The most promising candidates are the ones in the middle of the affordability spectrum- those whose mortgage payments aren’t crippling and hence have a realistic chance of avoiding foreclosure with the help of a modification.

Those whose mortgages aren’t guaranteed by the FHA, but are owned by either Fannie Mae or Freddie Mac, are also in a fortunate position. Since Fannie and Freddie are in a government trusteeship, mortgage servicers don’t need the approval of private investors before approving a modification. [For those who aren't sure whether they fall into this category, you can enter your street address here to confirm]. Still, the mortgage services themselves must grant the approval, and as with FHA loans, they are compensated for the government for doing so.

Such servicers are looking for borrowers whose housing payments (principal, interest, taxes, and insurance) exceed 31% of gross monthly income. In this sense, borrowers whose income has fallen (but not disappeared) since taking out their mortgages, and those whose payments have increased (as a result of adjustable rate reset, for example) are the most likely candidates. Typically, such borrowers will have see their interest rate reduced to 2%, though loan balance/principal won’t be adjusted.

As with FHA loans, servicers are looking for borrowers that are in need of aid, but not desperately so. Borrowers without any income won’t qualify, because the risk of foreclosure will still be high after modification. Those with healthy savings or other assets also won’t qualify, since most servicers will judge them capable of making mortgage payments without a reduction. The key is “massaging” your financial position so that you fall into the sweet spot.

The much-maligned Federal loan modification program appears to be gathering momentum, as the Obama administration recently announced that 500,000 mortgage loans have now been modified. This was hailed as a milestone, and the administration claims that it was reached ahead of schedule. Given the program’s slow start (reported in depth by the Mortgage Calculator), it is certainly cause for celebration.

Leading the pack are Citigroup, Wells Fargo, and Lehman Brothers, which have modified 33%, 20%, and 33%, respectively of their eligible loan pools. According to a government report, “In the second quarter, 78% of loan modifications involved actually reducing borrowers’ payments, up from 54% in the first quarter,” which means that “mortgage servicers became less likely to merely add missed payments to the balance of a reworked loan.” Even better, lenders have modified more than two million loans outside the auspices of the government program, through the industry alternative, known as the Hope Now program.

According to the government, the program aims to be even more successful, in terms of both individual lenders and on an aggregate basis. The stated objective remains 3 – 4 million modifications. Towards this end, the government will continue to incentivize lenders and release “report cards” on their progress.

Criticism of the program continues to pour on from all sides, however. Most of it is centered on the notion that the program is both naive and undercapitalized. Asserts one critic, “Borrowers whose mortgages are modified tend to default on the new terms at a high rate. Of the estimated 4.5 million homeowners in foreclosure or headed there with mortgages 90 days or more delinquent, the program ultimately will save only 1 million of them.”

In addition, there is concern that a fresh wave of delinquencies and potential foreclosures threatens to outpace the government’s efforts. To this, Treasury Secretary Geithner offered the following hedged response: “While the pace of loan modifications now exceeds that of new foreclosed loans, a ‘large number of families’ remain at risk of losing homes they might be able to afford if they could change their mortgage terms.”

There is even criticism coming from within the government, much of which is grounded in familiar partisan battles. Republican lawmakers argue that the $75 Billion budgeted for the program is wasteful and unnecessary, while their Democrat counterparts insist that additional funds need to be allocated. Despite the disagreement, “A Congressional Oversight Panel formally urged “Treasury to reconsider the scope, scalability and permanence of the programs designed to minimize the economic impact of foreclosures and consider whether new programs or program enhancements could be adopted.”

Finally, there are concerns that the program continues to benefit lenders and servicers, at the expense of borrowers. Lenders reap financial rewards for modifying loans even when the result is an increase in debt for the borrower. “These Treasury people are all from Wall Street, and they’re not doing anything but protecting Wall Street. They don’t care in the least about protecting homeowners,” argued one lawyer. The government, however, is doing its best to make sure loan modifications are carried out in an upright manner, and is in the process of officially prohibiting the charging of upfront fees in association with modifications. Progress is slow, but at least it’s progress.

Based on all measures, the government’s role in the housing/mortgage markets has expanded rapidly since the onset of the credit crisis in 2008. “In fact, more than 80% of the new residential mortgage loans made this year benefited from some form of government support, according to the trade publication Inside Mortgage Finance.” Experts reckon that if the government were to exit, the nascent recovery would collapse immediately. Unfortunately, due to budgetary problems, this is becoming increasingly likely.

Let’s begin by examining the government “intervention” in greater detail. First, there is the government tax credit, which provides up to $8,000 towards the purchase of a new home, by first-time homebuyers. Originally designed as a tax credit, the cash can now be “monetized” and put towards a down-payment. It is impossible to understate the success of this program: “Deutsche Bank estimates the credit has helped generate 350,000 sales, about half the increase in single-family home sales in the past six months.”

Unfortunately, many analysts are skeptical that these sales were facilitated by the tax credit. Rather, the assumption is that buyers who would have entered the market in the next couple years anyway, simply moved their plans forward to take advantage of both the credit and weak prices. It stands to reason, then, that if the program expires in November (as scheduled), that demand could plummet, and home prices could once again sink.

Then, there is the government takeover of Fannie Mae and Freddie Mac. Both companies are basically insolvent, and if not for the injection of $200 Billion funded with taxpayer money, it’s safe to say that the market for mortgage securities wouldn’t be functioning. At some point, the government will have to come up with a viable long-term alternative to the current situation, the implications of which are still unknown. [See related post: "Could Fannie and Freddie Disappear?"].

The Federal Reserve Bank has also played an important role in keeping the market for mortgage-backed securities functioning smoothly. The Fed has purchased at least $800 Billion in such securities as part of its quantitative easing mission, with total purchases to reach as much as $1.45 Trillion next March, when the program is slated to come to an end. Again, it’s impossible to understate the impact on mortgage rates. Since intervention began, the spread between mortgage rates and Treasury rates has narrowed by .7%, implying that rates would not be toying with record lows if not for the hand of the Fed. As the Fed slows down and eventually stops its purchases, mortgage rates are expected to rise dramatically. [Chart courtesy of WSJ].

Last but not least, there is the Federal Housing Administration (FHA), which has become the major player in the mortgage market. While the housing bubble was inflating, less than 10% of all loans were backed by the FHA. Nowadays, that figure is closer to 40%, and for some lenders, as high as 90%. When you consider that the FHA recently raised its limits, it’s fair to say that obtaining a mortgage would be much more difficult otherwise.

The FHA has also been among extremely aggressive in executing loan modifications, in contrast to private lenders, which continue to drag their feet. Under the terms of the FHA program, borrowers are only required to pay interest on 2/3 of the outstanding principal balance. The remaining portion of debt is not forgiven, but must be repaid only in the event of a sale or refinancing.

Regardless of whether this saves the organization money – as it alleges – it still results in a net loss on every mortgage that it insures. Given also that a higher proportion of FHA loans are delinquent (when compared to uninsured loans), it’s inevitable that its role in the housing/mortgage market will soon decline. Its reserves have already fallen to the lowest level in 75 years, and the government has announced that drastic measures will be required if a bailout is to be averted.

Regardless of what happens, you can be sure that obtaining a mortgage and buying a house are both due to become more difficult.