Believe it or not, there is no catch to the HFA loan program. Qualifying borrowers (namely those with credit scores above 680 an strong financial positions) need to make down payments of only $1,000 apiece in connection with the 30-year fixed-rate mortgages that are being offered. Origination fees are low, and unlike with FHA loans, mortgage insurance will not be required. “The pilot program is called ‘Affordable Advantage,’ and it has now been adopted by three states — Massachusetts, Wisconsin and Idaho. (Other states, such as Pennsylvania, California and Colorado, have similar state programs.)” HFAs will underwrite the loans, and the National Council of State Housing Agencies (NCSHA) and Fannie Mae have agreed to purchase them, stepping in to fill the void left by wary private investors.

It goes without saying that this program is controversial, not least because all of the risk is being assumed by government agencies. The main concern is that if housing prices were to fall further, all of these borrowers would immediately be underwater. That would almost certainly be problematic for borrowers that need/wish to sell their homes, because they would be on the hook for the difference. Even if they were to remain in their homes, such borrowers would have been done a disservice. One has to wonder why the government is going to such lengths to further promote homeownership when such a policy was largely responsible for the current mess. The class of homeowners that is being targeted by this program is inherently vulnerable to default since by definition, they are barely able to afford the homes that they are mortgaging.

Meanwhile, the underwriting guidelines for FHA loans are finally getting tougher. “High-risk borrowers whose loans were flagged by the automated system could soon be subjected to a more in-depth manual review by the lender’s underwriting staff.” In practice, this means that borrowers with credit scores below 620 will have to meet minimum financial benchmarks in order to qualify. Those with scores below 580 will have to make down payments of at least 10%, and those below 500 will be barred from obtaining loans altogether. In addition, seller concessions (the seller practice of raising the price of the home in exchange for contributing equity to the buyer) will be capped at 3%.

Finally, the FHA will allow underwater borrowers to refinance into FHA mortgages. The only catch is that the current lender must agree to cut the principal by at least 10%, and that total mortgage debt cannot exceed 115% LTV. There are also bills floating through Congress that would raise the required down payment for all FHA borrowers to 5%. Given that the default rate on FHA loans is a whopping 14% and that it is facing financial troubles, such a proposal seems destined to become law. The FHA has already raised insurance premiums for its loans. If the housing market remains weak and defaults continue, it might have to raise them again.

Over the last few months, Mr. DeMarco has unveiled a wave of new initiatives designed to fulfill the government’s role as conservator: to “conserve their assets and get money back where it is owed.” First, he mandated that Fannie and Freddie would not enter into any new businesses, and would instead focus on the products and services with which they are already involved.

Next, he announced that borrowers who strategically default (i.e. have the financial means to keep paying but choose not to) on their mortgages will be barred from receiving a government-financed mortgage for at least the next seven years. [In practice, that could bar them from receiving any mortgage, since lenders would be nervous about originating any loan that could not easily be repackaged and sold].

Finally, he issued subpoenas (on behalf of Fannie and Freddie) to 64 financial institutions that act as trustees for pools of bundled mortgages, known as Collateralized Mortgage Obligations (CMOs). The purpose of the subpoenas is to collect information on the CMOs in order to ultimately ascertain whether fraud was committed by the borrowers and/or the trustees, themselves. If such turns out to be the case, Fannie and Freddie will be in a position to demand that the trustees repurchase the bonds. Already, more than $5 Billion in such repurchase requests have been issued, though it’s not clear how much money has actually been collected.

While the upshot for taxpayers of all this is clear (reduced losses from the government conservatorship), how borrowers will be affected is more opaque. For one thing, the consequences of strategic default will be severe. Before, it was commonly believed that default/foreclosure would only stain one’s credit report for 2-5 years, after which point one could theoretically return to the mortgage market.  The recently-implemented 7-year ban is tantamount to a blacklist; strategic defaulters should expect to become long-term renters.

I haven’t heard anything about lender lawsuits or criminal prosecutions of borrowers that committed mortgage fraud during the expansion of the housing bubble, although that’s not to say that it isn’t happening. At the very least, you can expect that lenders will be increasingly vigilant (as a result of both internal pressure and enhanced government regulation) in combating borrower fraud and misrepresentation of one’s finances.

Finally, it means that obtaining a mortgage will continue to be difficult. The cash resources of Fannie and Freddie are strained, the Fed has stopped buying mortgaged-backed securities, and private investors are increasingly staying away because of low yields and high risk. For those of you that are able to clear these formidable hurdles, you can expect a rigorous verification of your finances.

In its current form, the bill would effect changes to three main aspects: documentation, fees, and consumer protection. [The WSJ deserves credit for this classification]. In terms of documentation, lenders will be required to obtain full proof of borrowers’ assets and income, and to verify this information again immediately before the loan is closed. That’s not to say that no-documentation loans and stated-income/stated-assets loans will be disallowed; rather, it means that lenders that choose to make such loans will be required to maintain some “skin in the game.”

Specifically, a minimum of 5% of the loan balance must be funded directly by the lender, such that it has a direct financial stake in the repayment of the loan. [Currently, most lenders seek to maintain 0% exposure to most loans, preferring instead to sell them off to investors]. As a result, it is expected that the riskiest types of mortgages will become more expensive (to offset the higher risk to the lender), less common, and hence less disruptive to the mortgage finance system in the event of a crisis.

With regard to fees, there will probably be some kind of standardization, especially for vanilla fixed-rate mortgages. At the very least, lenders will be limited (or barred outright) from assessing prepayment penalties, especially on the riskiest types of mortgages. This way, borrowers that wish to refinance out of risky loans can do so without having to worry about being penalized by their lender.

In addition, mortgage brokers will probably be forbidden from receiving commissions in the form of Yield-Spread Premiums (YSP), because such creates a perverse incentive for them to steer borrowers into the riskiest and most expensive loans. Instead, “The loan originators could receive a commission based on the loan amount and bonuses on the [volume of] loans they do, but not based on the rates or the terms of the loan.”

Third, the bill would sponsor the creation of a new Consumer Financial Protection Bureau. This agency would have broad and far-reaching powers to monitor all aspects of the mortgage process. It would protect consumers from lender abuses, and presumably would require increased disclosure and counseling for borrowers that wish to obtain risky loans. It could also conceivably monitor the appraisal process, and to make sure it remains immune from the pressure of aggressive lenders.

Finally, the bill would allocate additional short-term funds towards the further alleviation of the housing crisis. There would be a $1 billion emergency homeowners’ relief fund and a $1 billion for redevelopment of abandoned and foreclosed homes. More information on this will be forthcoming if/when the bill passes. (A target date of October 1 has been set).

In hindsight, it appears that the apparent stabilization of the housing market was due almost entirely to the government homebuyers tax credit, which has since expired (for the second time). The most recent figures suggest that the housing market is still not reached the point of self-sustainability, and is still dependent on government support in order to function. It is especially worrying that the housing credit technically won’t expire until June 30 (for those buyers that completed deals prior to April 30), and yet its expiration is already reflected in the numbers.

Throughout the rest of 2010, the market is expected to remain anemic: “If there’s truly a ‘double-dip‘ in store, that would mean drops of around 10-15%.” However, there will be important regional differences: “We are likely to see significant declines in sales in the South and the Midwest, and modest declines in the Northeast and West,” predicted one economist. In addition, lenders are still holding on to an enormous “shadow inventory” of actual and potential foreclosed properties, which will likely drive prices lower when they are ultimately released onto the market.

One has to wonder whether this isn’t a lost cause, not to mention a huge waste of taxpayer money. When you consider that housing prices are probably higher than they otherwise should be (and should have been during the last 6 months), the tax credit essentially amounts to a gift to sellers. Don’t tell that to Senate Majority Leader Harry Reid, who is working to extend the tax credit (to buyers that signed contracts prior to April 30 but haven’t yet closed) for an additional three months. To be fair, the Treasury Department noted that “180,000 transactions that are eligible for the tax credit may not close by June 30 because of delays ” ‘in the closing process.’ ”

For everyone else, it might make sense to simply bide your time and wait for the housing market to hit bottom (for real this time) before diving into the market. For those who are still determined to enter the market, there are a handful of private and local government homebuyer grants that you may qualify for.

If anything, the chart understates this disconnect, since the Treasury Department initially projected that HAMP would serve 4 million borrowers from beginning to end. “Overall, more than 1 million borrowers have seen their mortgage payments lowered under the program, but the majority, 630,000, still have to prove they qualify for the program and are in limbo.” Ultimately, the program has (permanently) assisted a mere 300,000 borrowers.

The two main gaps in the program are clearly illustrated in green. The first gap represents the shortfall of borrowers that are technically eligible for assistance but have not received any. This is due to a number of reasons, namely issues with paperwork, lender inertia/ineptitude, and confusion over “jurisdiction.” For example, many borrowers are forced to go through their loan servicers to apply for the modification even though it is their lender / mortgage owner that will ultimately decide whether to approve it.

The second gap, which I alluded to above, is occupied by the group of borrowers approved for temporary modifications but rejected for permanent modifications. “The number of borrowers who were dropped reached more than 280,000 in April…That compares with about 157,000 borrowers who had lost their mortgage aid in March and means that more than one of every five borrowers who have entered the program eventually lost their aid.” Sadly, the number of borrowers dropped from the program is outpacing borrowers who are approved. The Treasury Department attributes this to paperwork snafus and borrowers falling behind on their new lower mortgage payments.

If there is any silver lining, it is that private lenders are picking up some of the slack: “About half of the those dropped from the federal program received another type of loan modification from their banks.” Bank of America has shaved more than $3 Billion from the loan balances of nearly 50,000 borrowers. Wells Fargo has lopped off $2 Billion from a comparable number. While the majority of borrowers are receiving such generous treatment, it’s certainly better than nothing.

If you still believe that you are eligible for a modification (HAMP or private), you should contact your lender. With the foreclosure crisis showing no sign of abating, lenders may become more aggressive in modifying loans. In addition, with unemployment still high, Congress is in the process of allocating more funds for government modifcation programs. The process is certainly frustrating, but for borrowers that comply with the requirements, the savings can be significant.

Alas, there are still no serious plans afoot to end the deduction. According to Shaun Donovan, Secretary of the Department of Housing and Urban Development (HUD), “We’re not actively looking at this. It’s not something that we have a policy group on or anything at this point.” In the same speech, however, Donovan noted that ending the deduction would be a step in the right direction, from the dual standpoints of government housing policy and deficit reduction.

What exactly is the NSP? According to the Department of Housing and Urban Development (HUD), which is charged with administering the program, it “provides grants to every state and certain local communities to purchase foreclosed or abandoned homes and to rehabilitate, resell, or redevelop these homes in order to stabilize neighborhoods and stem the decline of house values of neighboring homes.” Rather than try to directly avoid foreclosure (by making mortgages more affordable for at-risk borrowers), the NSP attempts to mitigate foreclosure indirectly by attacking the glut of unsold, undesirable homes. In addition to making a dent in the foreclosure crisis, NSP is also intended to stimulate employment (i.e. contractors must be hired to renovate the homes) and revitalize neighborhoods that have been ravaged by foreclosure and have become hot-spots for crime.

State and local governments must first identify the properties, purchase, and renovate them (using funds from their local budgets). Then, the homes are sold (at market value) to qualifying families, which pay for the properties presumably through mortgage loans that they qualified for and obtained independent of NSP. If there is a disparity between the market value of the home and the amount that the local government spent to buy it and fix it up, that shortfall (up to $80,000) can potentially be covered by NSP grant money. As long as the buyer remains in the home for 20 years, the grant is “forgiven” by the government. If the home is re-sold in the interim, however, the grant must be repaid as though it were a secondary mortgage. (This is intended to discourage speculation).

Presumably, all of the NSP funds have already been allocated to specific state and local governments. However, it will take time for these funds to actually be deployed towards the purchase and rehabilitation of actual properties. If you want to participate in this program in any capacity (whether as a taxpayer/voter, contractor, borrower, etc.), you can view a breakdown of fund allocation by state and locality, and browse a list of grantees.

In fact, Alan Greenspan, himself, estimated that “ four-fifths of the trifold increase in American households’ mortgage debt between 1990 and 2006 resulted from ‘discretionary extraction of home equity.’ ” In other words, most new mortgage debt was created as a result of refinancing (which increased the appraised value of the properties), rather than debt to fund purchases of new homes. “In 2005 alone, U.S. homeowners extracted a half-trillion-plus dollars from their real estate via home-equity loans and cash-out refinances. Some $263 billion of the proceeds went to consumer spending and to pay off other debts.”

The link between cash-out refinancing and foreclosure is surprisingly cut-and-dried: “For every 1 percentage point increase in its share of subprime mortgages that are cash-out refinances, the likelihood of foreclosure in that state goes up by one-third of a percent.” This connection is not difficult to comprehend since borrowers with less equity will necessarily have a more difficult  time repaying their mortgages, either for lack of wherewithal or lack of motivation (perhaps resulting from being underwater).

There are very clear lessons here. First, borrowers should exercise extreme caution when increasing the balance (via a refinancing) of their primary mortgage. This is true if the funds will be pumped back into the home, and especially true if the borrower intends to withdraw some of the proceeds, since this directly increases the likelihood of default.

From a policy standpoint, it’s clear that cash out refinancing should be heavily regulated, if not banned outright. Some experts have pointed to Texas, where the incidence of both foreclosures and underwater mortgages are well below the national averages. By no coincidence, “There, Cash-outs and home-equity loans can’t total more than 80 percent of a home’s appraised value. There’s a 12-day cooling-off period after an application, during which the borrower can pull out. And when a borrower refinances a mortgage, it’s illegal to get even $1 back.” Texas takes these rules so seriously that they are enshrined in the State Constitution.

It’s unlikely that the imminent federal overhaul, in all its glory and fecklessness, will include a similar provision. That’s unfortunate, since the data clearly shows that if a repeat housing bubble is to be avoided, the most effective measure might just be to ban cash-out refinancing.

Thus far, the only meaningful involvement by the courts has seen renegade judges unilaterally challenge the authority of lenders on a case-by-case basis. Sometimes, they have eliminated mortgages completely for homeowners facing foreclosure, but these stories remain the exception. For the most part, they have merely rubber-stamped the foreclosure petitions of lenders, since the law is the law.

According to experts, it is unfortunate that bankruptcy courts haven’t been vested with enough power to really help homeowners work around foreclosure: “A big advantage of bankruptcy over government-subsidized modifications is that bankruptcy is a difficult process that does not entice anyone to purposely default in order to get better repayment terms.” In other words, government programs are currently structured such that homeowners must (deliberately) default before they become eligible for relief. If the courts were involved, however, this incentive would disappear.

Under current laws, courts don’t have the power to modify primary mortgages, unless the borrower has first declared bankruptcy. Even then, the lender will still probably be successful in foreclosing on your home if it is determined that you can’t afford to continue making mortgage payments. [Thanks to aggressive lobbying, mortgage debt and student loans are basically "exempted" from the bankruptcy process].

If the borrower files for Chapter 7 Bankruptcy, then he can usually achieve a temporary stay of foreclosure. While this will give you automatic relief, the lender can usually petition to have the stay lifted within 3-4 months, which means that at best, this is merely a stopgap measure. If the borrower instead files for Chapter 13 bankruptcy, he can usually work out a repayment plan for the missed mortgage payments. Unfortunately, this procedure won’t do anything to reduce the size of one’s primary mortgage. (Second mortgages may be eliminated, but bankruptcy courts are barred from meddling with the primary mortgages). Rather, it will help those suffering from “temporary” financial distress that still have enough income to remain in their homes.

However, common sense dictates that those who could still afford to pay their primary mortgages probably wouldn’t go through the hassle of filing for bankruptcy, except in rare circumstances where their other debt was crippling, which means this avenue is basically useless. Fortunately, some institutions have started to lobby the government to think about changing bankruptcy laws, for the sake of creating an end-all solution to the foreclosure crisis. Let’s hope that they succeed!

Just like with its predecessor programs (HAMP, etc.), lender participation in HAFA is completely voluntarily. Instead of forcing participation (which would be unconstitutional), the government instead will try to encourage participation through incentive payments. Lenders will receive $1,500 for processing a short-sale, investors will receive up to $2,000, and second mortgage holders stand to get $3,000, a pittance relative to what they are owed in most cases, but better than the $0 that they would probably get in the event of foreclosure. Even borrowers (who in most cases require no incentive) are eligible for up to $3,000 in “relocation assistance.”

Before a homeowner can qualify for HAFA, he must first apply for a HAMP loan modification. Those who are rejected outright or miss payments (doesn’t this create a perverse incentive?!) will then become eligible for a HAFA short-sale. The borrower must also demonstrate that the mortgage is unaffordable (i.e. exceeds 31% of gross income) and that without lender intervention, loan default would be imminent. (In addition, the unpaid mortgage balance cannot exceed $729,500, the property must be a primary residence, and the mortgage must be owned by Fannie Mae or Freddie Mac).

Within 30 days of being denied a loan modification, the lender MUST make a short-sale offer to the borrower in the form of pre-approved terms and a minimum sale amount. The borrower, then, has 14 days to agree. Once the home is put on the market, buyer offers must be submitted to the lender within 3 days, and the lender, in turn, has 10 days to respond. This latter provision is crucial to the success of HAFA, since the main complaint prior to its implementation was that short-sales took too long to process. This deterred many buyers from even making offers, because they knew it would be many months before the respective lender would even deign to respond.

Under the terms of the program, borrowers are relieved of all obligations after the completion of a short sale, and lenders are forbidden from seeking deficiency judgments. In fact, even if the short-sale cannot be completed, the lender is still required to accept a deed-in-lieu-of-foreclosure, which likewise eliminates all debt obligations. Because of the incentive payments, then, it is in lenders’ best interest to try to complete a short-sale.

It looks like this program has a pretty good shot as succeeding, and more than 100 lenders (covering 89% of all outstanding loans) have already signed up. Let’s hope that this is the last time the government has to announce a new program…I think they are running out of acronyms.