On March 4th the Obama administration will roll out it’s Housing Affordability and Stablity Plan, the President’s plan for the mortgage industry revamp. The plan is a group of three separate policies designed to target three separate (but possibly overlapping) housing problems. The first section of the plan targets the perceived problem that the values of properties securing home loans have declined below the outstanding balances on those loans, thereby prohibiting the ability of the owners to refinance to a lower rate and payment. (For a complete rundown on the contents of the plan see this Article in the Business section of NYTimes.com.)

My first concern about the first section of the plan is that the premise on which it is based is misstated. The plan concludes that “…under current rules, most families who owe more than 80% of the value of their homes have a difficult time refinancing.” This is a grossly inaccurate statement. The vast majority of homeowners who fall into the group affected by declining property values have mortgages underwritten according to Fannie Mae and Freddie Mac eligibility requirements. Fannie Mae and Freddie Mac guidelines allow homeowners to refinance up to 95% of the value of their primary residence. The fact that the plan misstates the symptom for the which the remedy is designed should create some degree of skepticism when evaluating the efficacy of the plan.

That said, the problem that declining values have created for a large segment of homeowners seeking to refinance to more acceptable terms is a significant problem. Due to the liberal loan-to-value limits that were utilized by mortgage lenders to establish transaction eligibility during the preceding decade, there are millions of homeowners who have mortgage loan balances that exceed the current value of their homes. In fact, there are a substantial number of homeowners who purchased or refinanced homes at loan-to-value ratios exceeding 95% that currently fail to meet Fannie Mae and Freddie Mac eligibility requirements for refinancing, even though the values of their homes have not significantly declined simply because their equity position was so small at the time they originated their existing loans.

The summary of the plan states that “Millions of homeowners have … through no fault of their own … seen the value of their homes drop low enough to make them unable to access these lower rates.” There are many who would take issue with the statement that homeowners who purchased homes for more than their current values are without fault.  Those areas of the country where home values have declined significantly in the past two years were areas where the values of these home had reached unsustainably high levels during the years preceding the decline. Buyers who purchased homes at prices significantly above a realistic price (based on objective historical trends) are not without fault. I’ve previously stated concerns that a plan permitting a principal reduction on a homeowner’s mortgage based on the perceived decline in the value of the collateral securing it could, in fact, lead to a windfall profit for many homeowners that appear to be affected by these lower property values. ( See, The Declining value fallacy: why principal reductions are not an appropriate response )

The concept of permitting homeowners to refinance without regard to the value of their existing home is not a new concept. Special programs, called “streamline” refinances, permitting borrowers with acceptable mortgage payment histories to refinance without regard to the value of their properties have existed on both FHA insured mortgages and mortgages held by Fannie Mae and Freddie Mac for more than two decades. The current version of the Fannie Mae/Freddie Mac programs do not permit borrowers to refinance if the value of their property is now less than it was at the time the loan was originated.  The FHA streamline refinance (only available where the existing loan was originated as an FHA loan) currently permits a refinance without the necessity of a new appraisal provided the loan amount does not exceed the existing loan amount.

 The President’s plan will reincarnate a modified version of the “streamline refinance” on loans currently owned or insured by Fannie Mae or Freddie Mac to permit refinancing provided that the amount of the new loan does not exceed the current value by more than 5%. (i.e. the loan-to-value ratio of the new loan cannot exceed 105%).

The plan, although a step in the right direction, falls short of the scope necessary to solve the current problem.  Since the government now owns about 80% of the two government sponsored entities (Fannie Mae and Freddie Mac) they should have instituted the same standards that FHA utilizes on their streamline refinances. Simply stated, the 105% LTV limit should be eliminated and borrowers should be permitted to refinance, provided that they are not in default, that the new loan amount does not exceed the original loan amount and that the transaction does not permit the borrower to receive any cash-out.  A slightly higher rate of interest or a higher fees could be charged on those loans that exceed the 105% limit that would compensate for the higher risk associated with the new loan.  Bear in mind that Fannie Mae and Freddie Mac would, in theory, be placed in a more favorable position since the the balance on the new loan would be no greater than the original loan amount and only slightly higher than the balance of the existing loan.  The lower rate and payment would decrease the likelihood of default by the borrower and in the unfortunate event of a subsequent foreclosure the delay would likely place the lender in a better position than if it had to foreclosed and resell the property securing the loan in today’s depressed market.

This type of plan would permit homeowners to refinance at lower rates, but would assess a minor penalty (in terms of higher pricing) to homeowners having to use this type of qualification mechanism. Homeowners who made smart financing decisions by keeping adequate equity positions and by choosing to purchase homes at values that were realistic would be able to refinance under standard guidelines that provide superior rate and pricing terms.

Whatever plan is instituted, it should not limit the ability to originate these “streamline” refinances to the servicers of the existing loans. Limiting the authority to originate these new mortgage loans to the institutions that currently service those loans will drive up the cost of financing for the consumer.  The fact is that the entities that service loans are inefficient originators. When they originate mortgages they do so at a substantial cost to the consumer. On a typical mortgage loan of about $300,000 the transaction costs paid by the consumer to obtain a new mortgage loan are up to $6,000 more through the big-volume servicers than on a loan at the same interest rate originated by and/or through more efficient mortgage bankers and mortgage brokers who do not service loans. As an incidental result of limiting these modifications or the origination of these streamline refinances to the existing servicers, undeserving banks who are already the beneficiaries of public bailout funds (specifically, CitiMortgage, Countrywide (now owned by Bank of America), Bank of America and Chase) would receive perks at the expense of the more efficient originators, once again rewarding the entities that bear a unproportionate share of the blame for the current crises.

My name is Ken, and that’s my take on it.