Having essentially conceded the failure of its cornerstone load modification program to achieve widespread mortgage relief, the Obama administration is changing tack. Its new strategy is to focus its attention on specific regional markets, rather than to address the entire national market with one program.

Specifically, the new initiative will allocate $1.5 Billion to the handful of states that have witnessed 20%+ declines in housing prices: California, Florida, Nevada, Arizona, and Michigan. “There will be a formula for allocating funding among eligible states that will be based on home price declines and unemployment.  Eligible [Housing Finance Agencies] HFAs that would like to participate must submit a program design to Treasury.  Program designs must meet funding requirements under the Emergency Economic Stabilization Act of 2008 (EESA).” It seems then that the responsibility to develop specific solutions will rest ultimately not with the federal government, but with the organizations that receive the funds.

This initiative is a recognition that the housing crisis is composed of a number of local crises, rather than one cohesive nationwide crisis. There are disparities in housing prices, sales, delinquencies, even interest rates, that exist between states, sometimes even between counties. For example, the delinquency rate in Florida is much higher than in California, even though prices have fallen about the same in both states. Thus, it makes the most sense that unique relief programs be developed for each state, or even each locality.

A number of ideas have already been mooted, including “measures for unemployed homeowners, programs to assist borrowers owing more than their home is now worth, programs that help address challenges arising from second mortgages; or other programs encouraging sustainable and affordable homeownership.” In fact, unemployment, underwater borrowers, and second mortgages have all served as obstacles to national relief efforts, and it is important that now they can and will be taken into account when designing programs.

For example, unemployment has made it difficult for many borrowers with temporary loan modifications to obtain permanent modifications, since they couldn’t even make payments during the trial stage. As a result, the state of Pennsylvania developed a program that will lend $60,000 to unemployed homeowners for up to three years, to be used to pay their mortgage as they look for work. It’s unlikely that California could afford such a plan ["Pennsylvania's (plan) is great but we probably have more unemployed people in San Diego County than they have in Pennsylvania."], but it could work in a state like Michigan.

In addition, underwater borrowers have found it difficult to achieve either loan modification or refinancing.  “About one-third of California mortgage borrowers owe more than their home’s value. Californians in foreclosure owe an average of $140,000 more than their home’s value…But banks have fiercely resisted efforts to get them to reduce the principal owed on those underwater homes.” Finally, borrowers with second mortgages have found it difficult to convince one lender – let alone two! – that they deserve a modification. State plans could overcome these obstacles by rolling both mortgages together in the case of the latter, and work with lenders to reduce principal in the case of the former. Due to the local nature of this program, the precise terms would depend on local circumstances.

Across the blogosphere, pundits and financial advisers are baffled by the failure of borrowers to take advantage of unprecedented low rates and refinance their mortgages: “There are quite a few mortgages that are in the money, meaning they are well within the zone where refinancing makes sense. Given where rates are right now, refinance activity should be quite a bit higher than it is.”  Low rates, goes the logic, won’t last forever, and eligible borrowers would be wise not to delay in refinancing their mortgages.

According to a recent report in the Washington Post, however, the fall-off in refinancing applications has little to do with borrower sloth, and everything to do with lender standards and housing market conditions. It’s not as if borrowers are sitting at home biding their time in the hopes that rates will fall still further. On the contrary, a steady faction has continued to seek out refinancing, but a greater proportion is being rejected. According to one lender, the rejection rate has risen from 5% to 25%. The main reason for this trend: the decline in housing prices.

On the surface, one wouldn’t necessarily expect the housing market to significantly affect mortgage refinancings. After all, the two are hardly related, right? Demand for refinancing is a primarily a function of interest rates, and shouldn’t depend on housing prices. However, the recent downturn in prices was so severe that many borrowers no longer meet the basic 20% minimum home equity threshold stipulated by lenders. Anyone who bought in the last five years with a minimal down-payment is probably nowhere near 20%, and may in fact be below 0%. So-called underwater borrowers have no chance of being approved for a conventional refinancing, even with a perfect credit score.

For such borrowers, the only alternative is to buy private mortgage insurance (PMI), and/or rollover a previous PMI to a new (refinanced) mortgage. Why isn’t everyone rushing out to do this? The answer is that it’s prohibitively expensive, requiring both a hefty upfront premium as well as annual payments. Given the uncertainty over housing prices, PMI premiums are rising, and borrowers are balking at committing to paying a premium indefinitely (since there’s no guarantee that one’s equity will return to 20% – at which point insurance is no longer required). The bottom line is that when PMI is factored in, refinancing no longer makes financial sense for anyone whose current mortgage rate is below 6%.

It’s ironic that now that many borrowers legitimately need a refinancing (as a result of the economic recession), they are unable to get one. The federal Making Home Affordable Refinancing Plan was unveiled to address this issue, but it lacks traction; to date, only 200,000 borrowers have been approved through the program, much less than the 5 million borrowers that were initially projected. The program is slated to expire in June.

Don’t let this pessimistic report discourage you. If your current interest rate exceeds 6%, you should still think about applying. [You can use our Refinancing Calculator to estimate savings]. Just maintain realistic expectations, and keep all of your options open.

As the name of our website implies (and as the #1 Google ranking confirms), we are THE online source of mortgage calculators. Unfortunately, there isn’t enough space in this post to explore all 22 of our mortgage calculator tools, so I’ll focus on one in particular: Home Affordability Calculator.

The purpose of this calculator is to help you figure out the maximum that you can borrow, under a given set of loan parameters. Many borrowers begin the process by trying to find the home of their dreams, and then worrying about if/how they will afford to repay the mortgage associated with it. A better (or at least more conservative) approach, would be to begin by using the Home Affordability Calculator to determine a reasonable borrowing amount, and then go out and look for a home.

The first input in the calculator is your estimated down-payment. If you already have an idea as to a down-payment (which will come from your savings, and not from the loan), you can key it in here. For those of you just beginning the process, you probably won’t have a strong idea of what kind of down-payment will be expected of you. For a conventional mortgage, 20-25% is the standard, while FHA loans typically require only 3.5-5%.

Next, estimate your interest rate. Again, for those just starting out, this will probably be impossible, especially if you aren’t even aware of prevailing market rates. You can find information on regional interest rate levels from the weekly Freddie Mac Primary Mortgage Market Survey. Given that interest rates fluctuate over time and that you may have to pay a higher rate if your credit isn’t perfect, it’s a good idea to be conservative when estimating your rate, perhaps by adding .5% onto an “average” rate [Note: it is assumed that points, which are used to "buy down" the interest rate will come out of your pocket, and hence are not included in the calculation. The same is true for closing costs. Some loans allow you to finance your points, but that is beyond the scope of this calculator].

Length refers to the duration of your mortgage. 30 years is standard, although 15 years is also an option. Estimated front ratio refers to the percentage of your gross (after-tax) income that your PITI (mortgage principal, interest, taxes, and insurance) will represent. The estimated back ratio refers to the percentage of gross income that all of your debt (mortgage, auto loans, credit cards, etc.) represents. Unless you have reason to believe otherwise, you can assume a 28/36 (front/back) ratio, which means that your PITI cannot exceed 28% of your gross income, and all debt (including PITI) cannot exceed 36% of income.

The next step is to enter all of your gross (after-tax) income into the income fields. You should include the income for all parties who will be listed on the loan documentation. The same goes for the debt fields. [Note that you cannot exclude the debt of one of the parties without also excluding his/her income]. This data will be used in conjunction with the ratios to determine how much you are ultimately eligible to borrow, so it’s important to be accurate and truthful.

Then, enter in estimated property taxes (usually expressed as a percentage), as well as homeowner’s insurance, and private mortgage insurance (PMI) which is paid both upfront and annually by high risk-borrowers (i.e. those whose down-payments are less than 20%) to mitigate against the risk of default. If your projected down-payment exceeds 20%, you can leave this field blank.

Finally, click the calculate button, and you will be provided with the maximum that you will be allowed to borrow under the parameters you entered. You can play around with the loan parameters (i.e. increase the down-payment size, change the loan term) and watch the results change accordingly.

It is important to remember that this represents an estimate only. When it actually comes time to obtain your loan, most of the inputs will probably be different from what you originally assumed, so it’s important to be conservative. Last, this formula is designed to show how much you are eligible (the maximum that the bank will lend you) to borrow, and not necessarily what you can afford to borrow. If the housing bust has taught us anything, it is that the gap between these two figures is often larger than most borrowers initially estimated. Plan accordingly, and be conservative!

Prior to the bursting of the housing bubble, the majority of borrowers probably had never heard the term mortgage-backed security (MBS) before, and the handful that had probably had only a vague sense of the vital function that they play(ed) in the mortgage finance system. Nowadays, most borrowers have at least a rudimentary understanding of MBS, thanks to the role that they played in the credit crisis. This role is evolving rapidly, however, and borrowers would be wise to stay abreast of these changes.

For those of you aren’t entirely clear, a mortgaged-backed security is simply a large portfolio of mortgages, bundled together for risk-management purposes, and sold to institutional investors. In theory, it’s a system that is designed to benefit everyone. Lenders are able to originate news loans freely without having to worry about holding them all on their balance sheets. Investors are happy because the MBS are structured such that a handful of individual defaults has minimal impact on the value of the whole portfolio. Borrowers, meanwhile, benefit in the form of lower interest rates.

In spite of the credit crisis, everyone is fighting to make sure that this system – or some semblance of it – remains in place. Currently, it is largely because of the interventions of the Fed and the government takeover of Fannie & Freddie that the market for MBS is even functioning. “More than 90 percent of home loans at the moment have some form of government backing, compared with about 30 percent at the peak of the housing boom.” In addition, the Fed’s $1.25 Trillion in purchases of MBS are keeping interest rates low, by “acting as a sponge, absorbing about $12 billion a week of what you might consider excess supply.” When either the government guarantees and/or the Fed’s purchases come to an end, surely the system will suffer a giant hiccup. The consensus is that when the Fed stops buying, rates could rise by as much as 1-2%, which could translate into more than $100,000 over the life of a typical mortgage. The Fed has attempted to allay these concerns by mulling an extension of the deadline of its asset purchase program for a second time (the original deadline was January 1, and the current deadline is March 31), but regardless, the end is near.

What will the new system look like? In form, not so much different from the current one. Namely, standards will be a lot tighter, That means higher credit score requirements, bigger down-payments, stricter documentation requirements, etc. From the standpoint of investors – who ultimately bankroll the mortgages – this means higher quality mortgages and greater transparency. As one such investor expressed, “I really want to know what the hell I’m buying.”

The government might also step in and beef up regulations. Lenders, might be required to begin holding a (larger) portion of mortgages that they originate on their balance sheets. “With some skin in the game, the theory goes, they would be more careful to ensure borrowers are screened properly. Another idea is for regulators to set a basic, industrywide level lending standard for things like down payments and borrowers’ debt levels.”

From the standpoint of borrowers, this translates into higher interest rates for prime borrowers, and even higher interest rates for everyone else.

If there’s any consensus surrounding current loan modification efforts, it is that they aren’t working. Depending on whose numbers you believe, between 1% and 2% of all eligible borrowers have had their mortgages permanently modified. While the figures for temporary modifications are more impressive, experts argue that most of these borrowers aren’t ultimately being helped, since they will likely default anyway. In this sense, loan modification is actually worsening their plight. [Chart courtesy of WSJ].

Anyone who has applied for a loan modification can surely attest that the most banks are usually willing to offer is a slight (and often temporary) reduction in one’s interest rate and/or lengthening the term of the mortgage. As advocates for borrowers point out, such efforts are quite in-effective since they do nothing to ease the long-term financial burden. Moreover, they don’t account for the fact that for many borrowers, the problem is not that their monthly payments are unaffordable but that their mortgages exceed the value of their homes. The issue for these borrowers is not they are unable to repay their mortgages, but that it is no longer economical to do so.

What’s the solution to this problem? The answer is principal reduction. Borrowers who are having trouble repaying their mortgages would be helped both over the short-term by a lower monthly payment, and over the long-term via a lower debt burden. Those whose mortgages are underwater, meanwhile, would have their equity restored, and thus have more to lose by “strategically defaulting.”

Today, we’re proud to bring you an interview with Dan Green, a loan officer with Waterstone Mortgage in Cincinnati and the author of The Mortgage Reports.

Read the rest of this entry »

It is a common misconception that loan modification was “invented” by the Obama administration to combat the current mortgage crisis. On the contrary, they existed long before the government catapulted them into prominence. Despite the fact that loan modifications require less paperwork and are inexpensive to process, however, they have been rare and characterized by drawn-out processes because it was (and still is) difficult to persuade one’s lender to voluntarily modify his mortgage. It had become the norm, then, for borrowers to instead apply for a refinancing, which is expensive and contingent on one’s credit score, but easy to execute for those who are approved.

In light of the Federal Government’s Home Affordable Modification Plan (HAMP), however, the tables have turned completely. Under the plan, lenders are incentivized (such that the costs to borrowers are theoretically nil) to modify loans for at-risk borrowers. Such modifications typically involve reduced interest rates, although some lenders have been known to cut the principal as well. Of course, it is now common knowledge that by almost every measure, this program has been an abysmal failure. Only 66,000 borrowers (as of Decemeber 31) have been approved for permanent modifications, far less than the 3-4 million that was initially touted.

In response, the government has taken to chastising lenders that aren’t aggressive enough in modifying loans, in the form of frequent “report cards.” Lenders blame borrowers, naturally, for not providing the necessary paperwork, and borrowers recriminate that the documentation demands are too onerous. The government’s latest attempt to remedy this discontent is to streamline the paperwork requirements so that borrowers need only to provide a request form for modification, proof of income, and authorization for the lender to check their tax history via the IRS. Despite these hurdles and the fact that delays of many months before being accepted (or rejected, for that matter) are common, the program still holds great appeal for borrowers. In fact, some borrowers are deliberately not making their mortgage payments, in a subtle attempt to demonstrate their financial plight to their lenders.

As a result of this shift and the simultaneous tightening of lending standards, it has become quite difficult to refinance a mortgage. The government has responded by unveiling a parallel program, this one aimed at refinancing. All loans that are owned by Fannie Mae and Freddie Mac (themselves “owned” by the government) are automatically eligible for refinancing. Even underwater loans – up to 125% Loan-to-Value – can be refinanced. Otherwise, the only option for those rejected for loan modification and desperate to refinance, is an FHA refinancing.

Given that mortgage rates are hovering around record lows, refinancing for many borrowers would achieve comparable cost savings to modification. One has to wonder, then, if after the expiration of HAMP and the return of the mortgage market to normal functioning (admittedly, this is an uncertain prospect) if the pendulum will swing back in favor of refinancing. With that possibility in mind, borrowers should think twice about deliberately skipping mortgage payments to increase their chances of modification, because such will also dent their chances of getting refinanced. At the same time, the fact that mortgage rates are projected by many to begin rising in 2010, the window on viable refinancing could soon close.

In short, it seems that for those of you who are genuinely at-risk of defaulting, keep talking to your lender about a loan modification. For everyone else, refinancing is probably still your best – and most realistic – option.

Previously a fringe issue, strategic default is expected to take center stage of the foreclosure “epidemic” that continues to sweep the country. This is due to two primary factors:

The first is that more than 20 million mortgages will soon be underwater (the mortgage exceeds the current market price of the home); that’s 25% of the total. More worrisome is that 5 million of these will be underwater by more than 25%, which is a “critical” threshold as determined by analysts. Of course, there is a certain arbitrariness to this threshold, but the idea behind it is that at a certain point, the idea of owing more than your home is worth takes on a real significance as parity in the near-term becomes less of a hope and more of a dream.

Even assuming that starting today, home prices will start appreciating by 5% per year, that means it will be five whole years (10 for a borrower that made a 25% down-payment) before a borrower that is 25% underwater can get back to the starting point of the mortgage. When you consider that underwater borrowers are predominantly located in markets that also experienced the largest bubbles (i.e. Nevada, Florida, Arizona), even assuming 3% a year looks generous at that point. When you further consider that some of those borrowers are more than 50% underwater, the idea of waiting 20 years before they can get back to even can seem sisyphean. Purely in terms of the numbers, then, there is already a critical mass of borrowers for whom strategic default will be attractive.

The second factor driving strategic default is increasing attention by the (mainstream) media, which appears largely indifferent – sometimes cautiously supportive – of strategic default. At the beginning of the credit crisis, when default was seen as “legitimate” (there was no way many of those borrowers could make good on their mortgages under current circumstances), nobody made much attention to strategic default. Those that noticed it thought of it as “baffling” (in the words of Wachovia), and a handful of columnists ventured to call it irresponsible.

Since the release of the University of Arizona Professor Brent White’s paper on the subject, strategic foreclosure has gradually gained mainstream acceptance. Professor White examined the issue from the legal perspective, noting that contracts are frequently broken when one of the parties determines that it’s in his best interest (i.e. the benefits outweigh the costs) to do so. Public opinion, meanwhile, has focused more on the comparison with Wall Street, which behaved irresponsibly during the years leading up to the credit crisis, only to avoid collapse by being out by the government. To hold borrowers up to a higher standard, goes the argument, seems unfair.

As I have argued in previous posts on the subject, for many people, it would indeed seem that the financial benefits outweigh the costs. In states where non-recourse loans are mandated, lenders are entitled to the home and nothing else in the event of foreclosure. In the majority of states, recourse loans are the norm, which means that a lender can technically sue for the difference in the event that a foreclosure sale turns up less than the value of the loan- though few lenders actually bother doing so. In addition, there are no tax consequences for the majority of defaulters, thanks to the Mortgage Forgiveness Debt Relief Act of 2007, which “applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately).” The only costs then are those associated with moving, and the inability to borrow for the next few years due to a flattened credit score. For many defaulters, these costs pale in comparison to the immediate savings from renting a comparable property rather than making mortgage payments.

The main argument against foreclosure continues to be a moral one. But even this is somewhat flimsy, when you consider that the possibility of default is an inherent feature of mortgages (that’s why borrowers have to pay interest!). This is especially the case with non-recourse loans, where a study recently determined that borrowers unwittingly pay lenders an extra $800, when compared to recourse loans. In these states, then, strategic defaulters can perhaps rest assured that one way or another, they paid for the right to default.

It looks like Fannie Mae and Freddie Mac are headed for the gallows. That’s good news for taxpayers (which have pumped close to $200 Billion into the mortgage giants since they were placed under government conservatorship in 2008), but bad news for everyone else, because the US mortgage system has veritably come to depend on them to function in its current form.

Speculation surrounding the fate of Fannie and Freddie has been building steadily over the last year. Some expect(ed) that the organizations would be broken up and sold to private investors. Others thought that they would be turned into fully public institutions, with explicit government support. The only consensus was that a return to their previous hybrid structures was unlikely. Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, cooled this speculation when he announced last week that, “The committee will be recommending abolishing Fannie Mae and Freddie Mac in their current form and coming up with a whole new system of housing finance.”

Of course, it’s unclear what this new system will look like, and even less clear when it will be implemented. That’s because while the Federal government has been active in the housing/mortgage market since the credit crisis (i.e. loan modification, Fed purchases of mortgage-backed securities, homebuyer tax credit, loan application/documentation reform, FHA mortgage assistance programs, etc.), not one of its initiatives has meaningfully addressed Fannie and Freddie, except for periodically allocating more cash to them.

Some commentators have already written off Fannie and Freddie as irrelevant, but that’s only because they have been (temporarily) been replaced by Ginnie Mae, which basically functions as F&F did before they were taken over by the government. In fact, the only mention that they have merited of late was in regard to shedding mortgage bonds from their portfolios (by forcing lenders to repurchase loans that were improper in hindsight), rather than accumulating more.

Whether we’re talking about Ginnie, Fannie, or Freddie, the idea is the same: the Federal Government remains an indispensable part – whether implicitly or explicitly – of the current system. Under any alternative system of financing, obtaining a mortgage would probably be more difficult, or at least more expensive (from an interest rate standpoint). However, the result of this could very well be to drive housing prices down further, in which case Fannie and Freddie would serve the same purpose in death as they did in life: to make home ownership more affordable and hence, widespread.