The program has also been modified slightly from its original form, in which only first-time buyers with a maximum combined income of $150,000, were eligible for the $8,000 tax credit. In its latest iteration, the tax credit will be available to an even wider demographic. First-time homebuyers will still receive a tax credit worth $8,000, but the income restrcitions have been raised to $250,000, which means that all but the wealthiest 2% of Americans are now eligible. In addition, those wishing to make a new home purchase (but are not first-time buyers) are eligible to receive $6,500 for so-called “Trading Up” purposes.

For many homebuyers rushing to close on a home purchase, the extension was no less than a windfall. It appears that many had orignally underestimated the amount of time it can take to close (sometimes several months); now that they have until May 1 to close, there is less of a need to rush. In addition, the tax credit credit can still be claimed in advane, in the form of a loan from the government. In this way, homebuyers looking to make a purchase now, won’t have to wait until filing their taxes to receive a reinbursement. Given that April 15 is right around the corner, however, this is probably less of an issue for those that take advantage of the program in the coming months. As an aside, it’s important to check with an accountant/tax-preparer to confirm your eligibility for receiving the credit, as the IRS has already identifief 20,000 caes of fraudulent/accidental claims by those who were ineligible.

In the short-term, there’s no question tha this tax credit will continue to provide support for the housing market. Many analysts have attributed the apparent stabilization of the housing market solely to this program. Given its expansion to include all but the wealthiest home-buyers and the removal of the requirement that it can only be claimed in association with a first-time home purchase, it will provide have an even greater impact in the months ahead. In fact, “The industry group is forecasting 5.69 million existing home sales in 2010, up from an anticipated 5.01 million this year. About 549,000 new-home sales are projected for next year, up from an estimated 397,000 this year,” a rise of nearly 15% from 2009 levels.

As for the long-term, that’s another story, altogether. ““Housing activity is likely to fall back once the tax credit finally expires, as some sales will have been brought forward from future months,” explains one analyst. Ideally, the economy will pick up during the interim, and cushion the fall after the program ends. In this way, the tax credit can be seen as nothing more than a giant bridge loan for the housing market.

Low-income borrowers have always been at a disadvantage when it comes to obtaining mortgage financing. State and local agencies have thus played a valuable, and even necessary role, in funneling cash to this under-served group of borrowers. As a result of the credit crisis, however, such agencies have had an extraordinarily difficult time obtaining capital, and many are operating at only 20% of normal lending capacity. Historically, they have been able to count on Fannie and Freddie to purchase their mortgages and satisfy their capital needs; since being nationalized in 2008, however, Fannie and Freddie have also had a difficult time meeting their capital needs, with 2009 bond issuance projected to be only 25% of 2007 levels.

30 states have already signed up for the program, and it is expected that more will follow. In order to participate, every agency will have to pay a fee for each mortgage that they originate, which should be offset by the lower interest rates and cheap access to capital. From the government’s standpoint, it is expect that these fees will defray all of the costs associated with the program. While there is no fixed budget, government officials anticipate healthy demand, and hence, healthy costs, perhaps as high as $35 Billion. Plus, the federal government will ultimately be on the hook for any mortgage defaults. As advocates of the program note, however, these state and local agencies have a strong track record. Despite targeting risky borrowers, they typically only issue 30-year fixed-rate loans, and require rigorous documentation of assets and income.

It is unclear how long the program will last, since it is being justified retroactively on the basis of a law passed in 2008. Government officials have been clear in their insistence that this initiative is intended to serve as a stopgap measures, and that these agencies should effect the government to fulfill their capital needs in the future.

From the standpoint of borrowers, this should provide a minor windfall, as loans can be used either for home purchases or for fixing up rental properties. Even before the inception of the credit crisis, such borrowers have largely been locked out of the conventional financing system. Now, they will have a chance to obtain mortgages, at reasonable cost. For more information, and to find an agency in your area, consult the National Low Income Housing Coalition.

By most measures, there has never been a better time to rent. While housing prices and interest rates remain favorable, rental costs are even more attractive, with ratios in many regional housing markets continuing to favor renting. Even in New York City, long perceived to be the nation’s most robust rental markets, is experiencing falling rents. Fundamentals (i.e. oversupply) are combining with rude economics (increasing unemployment, falling wages) to create one of the most attractive environments for renters in recent memory.

Many advocates argue that the government should ride this wave by formally ending at least some of its home ownership subsidies, such as the mortgage interest tax credit, FHA insurance, and guarantees for mortgage securities. Unfortunately, the vested interests which benefit from this system are enormous, and will not sit by idly as home ownership gives way to renting. From lenders to brokers, realtors to investment banks, there are literally trillions of Dollars at stake which are preventing a change in the status quo.

Renters did manage to score a token victory when it was announced last week that Fannie Fae had already initiated a pilot program that would enable to homeowners to remain in their homes for up to a year after foreclosure. This mirrors a similar move by Freddie Mac last March, and is in the same vein as an existing Fannie program which honors existing lease arrangement in rental properties facing foreclosure. Under the new program, the deed reverts back to Fannie after foreclosure, but the homeowner is given the option to rent the former home at market rate, which is typically well below the payment required under the preexisting mortgage. By most accounts, the program has proved to be a success, with a conversion rate of approximately 66% (i.e. 2/3 of homeowners opt for the deed-leaseback instead of eviction).

Of course, this initiative is not really grounded in any kind of altruistic desire to minimize foreclosure, nor does it aim to shift the balance back towards renting. Rather, it’s a simple business decision. Fannie realized that by delaying foreclosure in the practical sense, it could avoid dumping these properties on a market that is already saturated with foreclosed properties and taking a massive write-down from a short-sale. Instead, it can sit on the properties for a year while the housing market (hopefully?) recovers, while collecting a modicum of income from the homeowners-turned-renters.

Cynicism aside, renters should be happy for any break that they can get. With special interests and government incentives continuing to favor home ownership, renters are still fighting an uphill battle.

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.

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.

As almost everyone who takes out a mortgage is certainly aware, mortgage interest payments are tax deductible, which means the actual interest rate paid by the borrower is often significantly lower than the rate quoted by the bank. [The precise discount depends on one's tax bracket]. However, the understanding of most borrowers doesn’t extend much beyond this, which is problematic because it turns out mortgage-related tax matters are actually quite complicated.

For example, the tax benefit can only be claimed on mortgages under $1 million, and cannot generally be increased as a result of a refinancing, unless the proceeds are used to improve one’s home. Points, which are used to buy down the interest rate when the mortgage is first issued, are deductible in the year they are paid, as are loan origination fees. Lender fees, private mortgage insurance, and other settlement costs cannot be deducted.

As for home equity loans, the limit is $100,000. Paradoxically, the proceeds from a home equity loan cannot be used in relation to the home in order to be eligible for the deduction, but can be used for almost anything else, from credit card payments to school tuition, etc. If the borrower is subject to the Alternative Minimum Tax (AMT), however, the opposite applies, and the proceeds MUST be used towards the improvement of the home in order for the interest to be tax deductible. Confused yet? If so, the chart below represents the best summary of the IRS rules I have ever come across and should be a great reference when it comes time to file your taxes!

The IRS doesn’t make things easier. According to the GAO assessment, taxpayers have to go through as many as 13 steps to determine first whether mortgage interest is tax deductible, second whether points are deductible, and third the size of any deduction. Included in the official tax forms is a handy flow chart, which borrowers can theoretically use to complete these steps. However, the increasing majority of taxpayers that use tax preparation software to file probably doesn’t ever see this chart. To make matters worse, the GAO report found that such software uses inconsistent methods to determine tax detectability, sometimes even asking the borrower to make the determination/calculation himself.

The main purpose of the report was to assess the ability of the IRS to properly determine and manage mistakes in mortgage tax issues, and in this aspect, the report was scathing. Due both to inadequate resources and insufficient information about taxpayers’ mortgages, mistakes were often allowed to slide. Although, the GAO found that the claimed deduction was understated as often as it was overstated, so the net result is probably a wash for the government.

In any event, it seems clear that something has to change. Either the IRS has to streamline paperwork associated with the mortgage tax deduction, or the government needs to revamp the rules. When you consider that the deduction costs the government $80 Billion in foregone tax revenues per year – especially in the context of the current budget problems – this could conceivably become a major political issue.

It’s quite clear that something has to be done. A new report by the Mortgage Bankers Association (MBA) recommends that the two companies be split into three smaller entities and continue to perform the same role that they do now. Under the proposal, the new firms would bear all of the direct risk from owning/underwriting mortgages, but would still enjoy some form of government guarantee. It’s not clear how this structure would facilitate stability, though it would probably increase transparency.

An unrelated report by the Government Accountability Office (GAO) examines the three options for Fannie and Freddie without actually offering an opinion as to which one is most advantageous. It is quite critical of the MBA proposal, arguing that “Creating ‘reconstituted’ for-profit government-sponsored enterprises, either publicly traded or owned by lenders, ‘could lead to even greater moral hazard. ‘ ” The alternatives – elimination, privatization, or full government takeover – however, are equally fraught with complications. Without Fannie and Freddie, it’s unclear how the mortgage markets would function, while a government takeover would probably result in a downsizing of their lending portfolios.

Before I continue, I want to stop and explain the role that Fannie and Freddie play in mortgage lending. Namely, the two firms act as liquidity providers, by using shareholders’ equity to purchase huge portfolios of securities mortgages (Mortgage-Backed Securities). And when I say huge, I mean it: “The companies, which own or guarantee about $5.4 trillion in U.S. residential debt and have accounted for about 70 percent of all new home loans this year.” By acting as the largest buyers, they enable mortgage lenders at the ground level to originate new loans, confident that they can be quickly repackaged and sold.

At this point, it seems the most likely scenario is that which was proposed by the MBA. It’s hard to understand how this represents a solution, but I guess it’s like the old joke about democracy: “It’s the worst system, except for all the others.” In other words, Fannie and Freddie have become the fulcrums of the mortgage lending industry, so their disappearance would be accompanied by a massive decline in new mortgage origination.

There are certainly analysts and policymakers that would argue this is a desirable outcome. The government has no business – explicitly or implicitly – playing with mortgages. If the government formally exited the mortgage lending industry (except to serve as regulator), it would probably lead to better risk management, since investors would have to assume the full risk of owning mortgage backed securities.

In addition, some of the slack caused by their disappearance would probably be picked up by private investors, since a portion of the capital currently invested in Fannie/Freddie would presumably be diverted to firms with similar interests. At the very least, it seems lending standards would tighten and interest rates would rise, but both of these phenomena have already started to obtain.

From the standpoint of current mortgagers, this won’t affect you much. Refinancing could prove more complicated, but it wouldn’t affect the terms of your current loan. For potential borrowers, it would most likely make it both more difficult and more expensive to obtain a mortgage. It’s tempting for me to urge you to preemptively go take out a mortgage lest the system changed tomorrow, but this is extremely unlikely, as the GAO estimates ” ‘potentially lengthy transition’ given their size.”

In other words, don’t let this affect your decision one way or another.

First of all, no longer can/should you assume that your home will appreciate indefinitely, if at all. This erroneous assumption is one of the biggest factors in the current wave of foreclosures, as mortgagers took out mortgages that were larger and riskier than otherwise advisable because they believed that they would be able to ultimately sell the house for profit.

In hindsight, the opposite proved to be true, and millions of homeowners now find themselves with underwater mortgages. In short, don’t think of your home as a conventional investment that will yield a return when it’s ultimately disposed of. A home has utility (which includes intangible value), and this should be the biggest factor in the purchase. Along the same lines, you need to consider that if your home does appreciate (or even maintain its value) it will require substantial upkeep, perhaps to the tune of 4% a year. While maintenance will provide an emotion return in the form of increased comfort/satisfaction, it will likely negate most, if not all of the financial return that will earn from owning your home.

Second, don’t make overly optimistic assumptions about future earnings, which could potentially leave you with a crushing debt burden in the even that your income doesn’t grow as planned. DINKs (Double Income No Kids) might think of themselves as the exception to this rule, because they are best in position to gamble. At the same time, this is somewhat irresponsible, since such individuals are most likely to witness their costs (kids….) increase faster than their income. This rule is especially important in the current economic environment, with income growth projected to be flat, on average, for the next few years.

The third piece of advice is to think small. When in doubt, go with the smaller home/mortgage. If your financial situation changes for the worse, you will be glad that you did. If, on the other hand, your financial situation improves, you can always upgrade to a larger home. In this case, a viable option is to simply expand your home, which will probably prove less costly, inconvenient than moving.

Along the same lines, you may want to consider taking out a “conservative” mortgage. Generally, this means going with a 30-year fixed rate mortgage. It could mean higher rates in the short-term, but there won’t be any surprises over the long-term. You will know from Day 1 exactly how much you will need to pay each month, regardless of whether home prices or interest rates change. In addition, bear in mind that a down-payment of more than 20% of the value of the home is least likely to lead to an underwater mortgage down the road. Hewing closely to your lender’s recommended income and asset ratios also makes it less likely that you will overextend yourself.

Finally, remember that there is an advantage to being a first-time homebuyer right now, in the form of a government tax credit. Ideally, you should consider the affordability of your mortgage irrespective of the credit, in which case your financial position will be especially robust. Still, human nature being what it is, I suppose you can’t be faulted for factoring in the government’s contribution to your down-payment. For some borrowers, the government’s 10% (maximum $8,000 contribution) could even eliminate the need to make a down-payment altogether. Bear in mind that time is running out on this program; while the federal government is mulling an extension, it is currently scheduled to expire on December 1. With potentially only two more month left, now’s the time to start filing the paperwork!

Three weeks later, however, it doesn’t look like much progress has been made. “Moody’s analyst Celia Chen…said that the number of modifications ‘will have to step up substantially in the remainder of this year in order’ to hit the 1.5 million to 2 million modifications that her firm estimates can be completed under HAMP by 2012,” which is less than half of the target of 4 million set by the government.

Demand for loan modifications is still running strong according to anecdotal evidence, which suggests that the fault lies primarily with the banks. According to government estimates, “Only 9 percent of eligible borrowers had been offered trial loan modifications through June.” By their own admission, banks remain reluctant to participate in the program. “In the Fed’s latest survey of senior loan officers, about 30 percent of banks said they were still tightening standards for both consumer and business loans.”

In some cases, banks have even acted counterproductive to the modification process, by dubiously suggesting that borrowers should deliberately fall behind on their payments in order to qualify for modification. It’s not clear whether such a strategy can ultimately be successful, but from a cost/benefit standpoint, it’s definitely not advisable. Horror stories abound, whereby “the modifications never came….These borrowers burned through retirement savings, destroyed their credit ratings and suffered mental and financial hardship,” and even foreclosure!

The government also deserves some of the blame for not making the program altogether transparent. One columnist seeking to navigate the process himself, wrote: “I discovered, just trying to access the program put me through a torturous weeks-long battle with red tape that made my previous interactions with the RMV and the IRS seem downright fun.” Unfortunately, his experience seems to be typical, and the relative handful of borrowers who were ultimately lucky enough to secure modifications were only able to do so after months of hard work and persistence.

The company itself has not been able to provide any clarity on the issue, since it has already ceased day-to-day operations, although Bank of America has stepped in and taken control over TBW’s servicing operations. From the standpoint of borrowers them, it looks like the transition will be relatively painless, involving little more than writing a check to a different entity at a different address. Ginnie Mae has issued a directive fully outlining this process.

Unfortunately, it looks like potential borrowers that were promised mortgages will have to restart the process with BOA or another lender. However, “If you had an appraisal completed as part of an uncompleted loan application, your loan file (including the appraisal) could be transferred to another lender. FHA appraisals are valid for six months.”

Apparently, most instances of lender closure/bankruptcy are resolved just as easily. Typically, the mortgage servicer “will sell its assets under the supervision of the bankruptcy court to another financial institution and transfer the servicing of your loan to another company.” According to the Federal Trade Commission, you must be notified at least 15 days before the effective date of the transfer by both the old and new servicers. “In addition, you have a 60-day grace period after a transfer to a new servicer. That means you can’t be charged a late fee if you send your mortgage payment to the old servicer by mistake and your new servicer can’t report that payment as late to a credit bureau.”

With regard to escrow accounts, the old servicer must continue to make payments (taxes, insurance, etc.) as usual. “Even if your servicer files for bankruptcy or goes out of business, it is responsible for making the escrow payments in a timely way.” As with the case of Taylor, Bean and Whitaker, mortgagers that have not yet closed will probably be canceled, although it’s important to speak to the lender anyway to confirm the status.