Time to Ramp Up Refinancing

Congress Should Pass New HARP Reform Bill

New legislation would help more homeowners refinance through the Home Affordable Refinance Program, writes John Griffith.

Sens. Barbara Boxer (D-CA) and Robert Menendez (D-NJ) speak to reporters in 2008 on Capitol Hill. The senators co-sponsored a bill to reform the Home Affordable Refinance Program.  (AP/Lauren Victoria Burke)
Sens. Barbara Boxer (D-CA) and Robert Menendez (D-NJ) speak to reporters in 2008 on Capitol Hill. The senators co-sponsored a bill to reform the Home Affordable Refinance Program.  (AP/Lauren Victoria Burke)

According to data released this past week, more homeowners are taking advantage of today’s historically low interest rates, thanks to the revamped Home Affordable Refinance Program—the Obama administration’s signature mortgage refinancing program. Still, millions more American families could benefit from refinancing but are blocked by Republicans in Congress, who refuse to pass a new program reform bill, holding back billions of dollars in consumer spending.

More than 1 million borrowers with loans backed by the government-controlled mortgage financiers Fannie Mae and Freddie Mac have lowered their monthly payments under the Home Affordable Refinance Program, and another 10 million have used more conventional refinancing plans offered by the two companies since April 2009.

In October 2011 the Obama administration announced major changes to the program to boost participation, with a focus on borrowers who are “underwater,” meaning they owe more on their mortgage than their home is worth. In the first quarter of 2012—the first period since the new rules were enacted—the number of loans refinanced through the program nearly doubled from the previous quarter, according to new data from the Federal Housing Finance Agency. And the number of underwater borrowers that refinanced their mortgage using the Home Affordable Refinance Program increased more than threefold over the same period.

Home Affordable Refinance Program refinances have increased dramatically since this past quarter's changes

Although these are encouraging numbers, Congress needs to step in to help the roughly 18 million more Fannie- or Freddie-backed borrowers who are current on their monthly payments and carry above-market interest rates, according to estimates from Moody’s Analytics. By refinancing to today’s low rates—typically well below 4 percent—many of these families can save an average of $2,600 per year in mortgage payments, according to the Congressional Budget Office.

To reach these borrowers, Congress needs to make at least two additional changes to the Home Affordable Refinance Program: increasing competition among lenders and eliminating unnecessary fees. Let’s examine each in turn.

Increasing competition among lenders

Current rules extend certain benefits to lenders who refinance their own program-eligible loans, but the same benefits are not available to other lenders interested in refinancing the same loan. This special treatment constrains competition among lenders, giving the banks that benefit “tremendous pricing power” to charge higher interest rates than necessary to program borrowers, according to analysts from Amherst Securities.

By offering the same benefits to all potential lenders, Congress could promote competition for program participation, thus increasing refinancing activity and lowering costs to consumers. In fact, this special benefit—known as protection from “put-back risk” in mortgage parlance—is the top reason why banks that are left out tend not to offer Home Affordable Refinance Program refinancing today, according to a recent survey from the Federal Reserve.

Eliminating unnecessary fees

Some borrowers currently pay an upfront fee to participate in the program—so-called loan-level price adjustments. Fannie and Freddie charge a fee of up to 75 basis points, or 75 cents on every $100 loaned, to borrowers with little or no equity in their homes who choose to refinance into regular 30-year mortgages. That’s up to $1,500 on a $200,000 mortgage—a significant barrier to refinancing for underwater or nearly underwater borrowers.

These fees serve very little practical purpose. They’re intended to compensate Fannie and Freddie for the added credit risk of refinancing an underwater loan. But since the companies already own or guarantee these mortgages, they bear no additional risk by lowering the borrower’s monthly payment. In fact, the lower payments actually increase the likelihood of repayment, thus lowering the credit risk borne by Fannie and Freddie.

Time for Congress to act

The recent reform bill introduced by Sens. Robert Menendez (D-NJ) and Barbara Boxer (D-CA) would mandate these and other necessary changes to the Home Affordable Refinance Program, including:

  • Eliminating all upfront fees to borrowers
  • Extending the same benefits to all eligible lenders, including waivers of certain representations and warrantees
  • Notifying all borrowers with Fannie- and Freddie-backed mortgages about the program, its eligibility requirements, and participating lenders
  • Other changes such as eliminating costs associated with home valuations and establishing penalties for certain investors and insurers that block program participation

Mark Zandi, chief economist at Moody’s Analytics, estimates that the proposed legislation would result in 2.9 million more refinancings, helping borrowers save a combined $7 billion annually in mortgage payments. Since many of these borrowers are middle-income families, most of those savings will likely be spent elsewhere in the economy, bolstering growth and creating jobs.

To be sure, not everyone would be happy with these changes. Some investors in mortgage-backed securities will see their interest income decrease as the underlying loans are paid back early. But any savvy investor is aware of this so-called prepayment risk when deciding where to put their money. It’s also worth noting that the Federal Reserve—by far the largest investor in Fannie and Freddie securities—has repeatedly called for more refinancing on Fannie- and Freddie-backed mortgages.

Since Fannie and Freddie hold some of these mortgages in their own investment portfolios, the taxpayer-supported companies also stand to lose some interest income. But at the same time, lower payments for borrowers will significantly reduce default rates on Fannie- and Freddie-backed loans, improving their overall risk exposure. Those costs and benefits will roughly balance out, leaving no net cost to taxpayers, according to the bill’s authors citing preliminary analysis from the Congressional Budget Office.

Who gains and who loses from the proposed Home Affordable Refinance Program changes?

That leaves lawmakers today with a simple question: Are you more concerned with struggling American homeowners and the overall health of our economy or the short-term interests of private investors?

Your call, Congress.

John Griffith is a Policy Analyst with the Housing team at the Center for American Progress.

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John Griffith

Policy Analyst