Housing Refinancing Reforms Still Needed

Changes to the Home Affordable Refinancing Program Could Go Further

HARP changes are welcome, but more can be done to help struggling homeowners, write Sarah Rosen Wartell and Jordan Eizenga.

A home has a real estate sign in front in Newton, Massachusetts. (AP/Steven Senne)
A home has a real estate sign in front in Newton, Massachusetts. (AP/Steven Senne)

The changes to the Obama administration’s Home Affordable Refinance Program announced last week by Fannie Mae and Freddie Mac are welcome, but more can be done to expand access to the program and allow additional struggling homeowners to refinance their mortgage at today’s historically low interest rates.

In October the two taxpayer-backed mortgage finance giants, Fannie Mae and Freddie Mac, in conjunction with the Federal Housing Finance Agency, released broad guidelines for how to increase mortgage refinancings through the Home Affordable Refinancing Program, or HARP, for homeowners who are “underwater” on their mortgages, owing more than the value of their homes. HARP, launched in early 2009, did not have the effect it was expected to as too few borrowers refinanced through the program. The proposed changes unveiled in October were designed to overcome this lack of take-up by making the program more attractive to both borrowers and lenders.

We wrote at the time that the changes could help stabilize the housing market but that the devil was in the details. Last week Fannie Mae and Freddie Mac released those details. In particular, the changes waived certain representations-and-warranties liabilities for lenders—representations and warranties that left lenders still liable for some statements about employment and creditworthiness of borrowers that discouraged lenders from considering refinancing under HARP—and reduced the upfront fees that borrowers must first pay to participate in the program. While we welcome changes that make it easier for borrowers to refinance under HARP, we are concerned that the representations-and-warranties relief is not sufficient to encourage high participation by lenders and competition between lenders for refinancing business.

HARP was designed to lower the mortgage rates for homeowners who are still current on their mortgages but were ineligible under traditional underwriting standards to refinance simply because the value of their property had dropped. This is a sensible policy given that home values dropped by nearly a third since their 2006 highs. By lowering monthly mortgage payments for struggling homeowners, HARP could help stabilize the housing market by reducing mortgage defaults. And since mortgage rates are near historic lows, refinancing could also put money in the pocket of struggling homeowners most likely to spend it in the economy.

Unfortunately, HARP had lower-than-anticipated participation by borrowers and lenders. Less than 1 million participated in the program versus an expected 4 million to 5 million borrowers that could have been helped by refinancing through HARP. Furthermore, only 7 percent of borrowers that refinanced through the program had mortgages more than 5 percent underwater, indicating that HARP was not benefiting households most in need—those whose mortgages were worth more than the value of their homes.

The changes announced last week extend HARP through the end of 2013 and attempt to make the program more attractive to borrowers and lenders by removing some of the barriers holding back their participation. First, Fannie and Freddie will expand access to the program to those borrowers who have a fixed-rate mortgage with a loan-to-value ratio greater than 125 percent, meaning the loan is more than 125 percent of the current value of the home. Fannie and Freddie will also allow a borrower that has been delinquent on one mortgage payment in the past year to participate, but on the condition that the delinquency did not take place within the last six months.

This is an important step in expanding access to HARP to those in most need—households with deeply underwater mortgages and those struggling to meet their loan obligations. An early assessment of the latter change alone by JPMorgan Chase & Co. suggests it will increase the number of eligible borrowers for a Freddie Mac-conforming HARP refinance by 3 percent to 5 percent, though no change is expected for Fannie Mae.

Second, both Fannie Mae and Freddie Mac greatly reduced, and in certain instances eliminated, loan-level price adjustments, which are upfront fees that borrowers with high loan-to-value ratios must pay when refinancing. For borrowers who refinance into a mortgage of less than 20 years, the fee will be eliminated entirely. For borrowers who refinance into mortgages of greater than 20 years, the fee will be reduced from 2 percent to 0.75 percent of the loan value—a potentially significant reduction.

A shorter-duration mortgage reduces the risk of default because borrowers build equity in their homes at a faster rate. This is an important step toward long-term wealth building. Problem is, many households cannot handle even modest increases in their monthly mortgage payments like those associated with shorter-duration Fannie Mae and Freddie Mac loans.

Furthermore, by reducing and not eliminating these loan-level price adjustments for many borrowers, Fannie Mae and Freddie Mac are leaving in place a key barrier to refinancing when it is in everyone’s best interest to eliminate them. These upfront fees are “of questionable use in the current situation, since Fannie and Freddie already insure these loans and will suffer the loss if they default,” wrote Mark Zandi and Cristian deRitis of Moody’s Analytics in October after the first announcement from the Federal Housing Finance Administration in October. “Lowering borrowers’ monthly mortgage payments increase the chance they will stay current, reducing insurance losses to Fannie and Freddie.”

Third, for loans refinanced by the same lender who made the original mortgage, Fannie and Freddie will relieve the lender of representations-and-warranties liability with respect to certain borrower characteristics. Traditionally, if a loan went into default within the first six months after the sale, Fannie and Freddie would ask the lender to buy the mortgage back if it could not prove that it made valid representations and warranties about a borrower’s income, employment status, and the value of the property against which the mortgage is secured. For this reason, lenders were often reluctant to refinance existing loans under HARP because it required them to take on the risk of making new representations and warranties on high loan-to-value ratio loans.

Under the proposed changes, so long as the borrower has not been delinquent over the previous six months and has only one delinquency over the past year, lenders must simply verify the employment status of the borrower and that he or she would see either a reduction in monthly payments or a more stable mortgage product by refinancing under HARP. The lender is also still responsible for any fraud it fails to detect. Beyond these requirements, lenders are released from borrower representations and warranties on the original loan, which should mean increased participation by lenders on refinancing their original mortgages.

Yet we have concerns about what was not included in last week’s changes to lender representations-and-warranties liability. For one, representations and warranties were not waived for loans refinanced by different lenders. In these instances, the representations and warranties that were made about the creditworthiness of the borrower on the original loan will be transferred to the new loan and thus the new lender. This could reduce competition for refinancing among lenders because the risk of refinancing is greater for lenders that did not make the original loan.

Competition is important in mortgage refinancing because it creates an incentive among lenders to participate in the HARP program or see their servicing income from their original loans reduced should borrowers refinance with another lender. Furthermore, the changes announced last week could actually increase barriers to refinancing under the program for borrowers with loan-to-value ratios below 80 percent. While Fannie Mae appears to offer representations-and-warranties relief for all mortgages, Freddie Mac provides no such relief to mortgages with loan-to-value ratios less than 80 percent. This means that borrowers with more equity in their homes may have a harder time refinancing than those that have less.

Given the concerns of all borrowers about incomes and jobs, Freddie Mac should offer representations-and-warranties relief to all mortgage borrowers. These loans may not be as vulnerable to foreclosure but the households could still use the relief and the increase in disposable income that they could spend in the economy.

None of this is to say that the announced changes are inconsequential. To the contrary, we believe that a revamped HARP as outlined in last week’s announcement could still play a role in strengthening the housing market and advancing economic recovery. Yet we believe more can be done to ensure higher participation of lenders in the program. Given the scale of the problems in our housing market, maximizing the number of lenders participating in HARP is crucial.

Sarah Rosen Wartell is Executive Vice President of the Center for American Progress. Jordan Eizenga is a Policy Analyst with the Housing team at the Center.

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Sarah Rosen Wartell