President Obama announced key changes to the Home Affordable Refinance Program (HARP) on Monday. The loosened guidelines are designed to help “under water” homeowners—those who owe more than the value of their homes—refinance their mortgages at lower rates and payments.
Started in 2009, the program cuts certain fees and allows negative equity loans backed by Government Sponsored Enterprises (GSEs) like Freddie Mac and Fannie Mae to be refinanced.
New HARP guidelines, which go into effect on December 1, include the following: 1) Borrowers must have no late payments over the past 6 months and no more than 1 in the past year. 2) The 125% loan-to-value cap is removed. 3) Appraisals and related fees are not required. 4) Only mortgages backed by GSEs are eligible. 5) Borrowers must be able to afford the new payments.
The general idea behind the program is to loosen federal guidelines for refinancing negative equity loans so homeowners can move to fixed rate mortgages with more affordable payments. In turn the refinance wave would add stability to the mortgage market by reducing certain risks, such as strategic default.
Here, the government implicitly backs the loans through GSEs (Freddie Mac and Fannie Mae) to encourage lender participation. Typically, a bank will not lend past the value of a home. In fact, many banks are reluctant to lend past 90% on home equity loans. In the event of default and eventual foreclosure, the lender stands to lose a great deal of money from low equity and negative equity loans. The ability to sell the loans to Freddie and Fannie removes that risk from lenders and passes it to the GSEs.
Approximately 1 in 5 homeowners (19.6%) in the Dayton area hold negative equity in their properties. After peaking in 2005, the average home price in Dayton declined from 2006 through 2009. Housing prices have largely stabilized over the past few years but have declined slightly in recent months.
In 2006, Montgomery County saw 5,076 foreclosure filings, a 25% increase over 2005, affecting only 3.4% of all households in the county. Despite such a small figure, the effects were significant. Increasing foreclosures contributed to declining property values in the Dayton metro area, leading, in part, to current number of negative equity loans. In 2010, the area saw more than 8,900 foreclosure filings. Foreclosures remain flat but have inched up over the past few months.
For Dayton area homeowners interested in the program, they should first contact their mortgage lenders to confirm whether or not their mortgages are Freddie Mac- or Fannie Mae-owned. The two GSEs own approximately 80% of all home loans, so that likelihood is high. A typical lender will make a mortgage loan and then sell it to either Freddie or Fannie and use those funds to make more loans.
HARP is a voluntary program, so lenders are neither required to participate nor are they prohibited from adding their own requirements, a feature that may temper the desired effects.
The effectiveness of HARP has also been questioned. According to the Washington Post, since HARP started in 2009, housing prices remain at record lows while nearly a quarter of all homeowners in the country remain under water. HARP does little to eliminate negative equity.
Likewise, HARP makes many of the same policy mistakes that contributed to the housing crisis to begin with. By loosening guidelines and guaranteeing participating loans, the federal government is inadvertently freeing lenders from typical due diligence and underwriting. All a bank has to do now is meet the few requirements and sell the loan into the secondary market.
On the contrary, if a bank would keep a mortgage on the books, its underwriters would assuredly make more thorough assessments of borrowers. Luckily in this case the new loans are not purchases, so a new wave of low equity mortgages will not result.
Another downside of the program is that it does not assist borrowers at risk of foreclosure, which is arguably a bigger threat to the housing market and the overall economy.