March 16, 2009,
Revised May 10, 2009, May 18, 2009, July 13,
2009, February 1, 2010
Most of the small print about the
Administration’s plan to help beleaguered mortgage
borrowers is now available at
www.makinghomeaffordable.gov. In my view, it is
coherent and well-thought out, but disappointing in
its limited scope. The program is designed to
provide benefits to owners who deserve to be helped,
rather than to reduce foreclosures and stabilize
The program name is "Making Home
Affordable", henceforth MHA, and it has two parts.
Part one is directed toward increasing refinance
opportunities for borrowers whose loans are owned or
guaranteed by Fannie Mae or Freddie Mac, and who
don’t have more than 5% negative equity on their
first mortgage. Borrowers with negative equity
greater than 5% don’t qualify.
The second part of the program
encourages payment-reducing contract modifications
of mortgages that are endangered by adverse events
affecting the borrower – such as a job loss or a
pending rate increase. The major tool for reducing
the payment is rate reduction, with balance
reductions only a last resort. Borrowers with
investment properties don’t qualify.
The limited scope of the program
is why its cost is estimated at only $75 billion, or
less than the amount required to bail out AIG. The
systemic impact will be correspondingly small.
Failure to Attack Negative Equity
The major limitation of the
program is that it does not attack the problem of
negative equity – mortgage balances larger than the
value of the homes securing the mortgages. Large and
growing negative equity underlies the sharply
reduced values of mortgages and mortgage-related
assets on the books of the financial institutions
holding them. These reductions in asset values have
eroded the capital of these institutions, which the
Government in case after case has had to replenish
to prevent failures.
The new program is focused
entirely on the capacity of borrowers to make their
monthly payments. Indeed, this is evident from the
program name, "Making Home Affordable". The major
tool for reducing the payment is rate reduction,
with balance reductions only a last resort in cases
where rate reduction and term extension can’t get
the payment low enough to be affordable.
This approach flies in the face of
evidence that balance reductions are critically
important in avoiding subsequent redefaults. A
recent study by Roberto G. Quercia, Lei Ding and
Janneke Ratcliffe, found that "Among the different
types of modifications, the principal forgiveness
modification [ie, balance reductions] has the lowest
redefault rate. We believe that this is because it
addresses both the short-term issue of mortgage
payment affordability and the longer-term problem of
negative equity…The results indicate that households
with negative home equity are more likely to
redefault over time, even when a modification has
initially lowered the mortgage payment." [Loan
Modifications and Redefault Risk, Center For
Community Capital Working Paper, March 2009].
Underlying the Neglect of Negative Equity
A different mindset is applied to
helping borrowers as opposed to helping financial
firms. Firms are helped in order to avoid the
systemic consequences of the firm’s failure. Whether
or not the firm "deserves" to be helped is wholly
irrelevant. Indeed, it could be argued that the
largest bailouts have been directed to the
least-deserving firms. This is unfortunate but
unavoidable because it is the system that is as
When it comes to assisting
mortgage borrowers, however, the mindset is that
assistance should be limited to those who have some
moral claim to Government assistance. Eligibility is
based on deservedness, with the systemic
implications swept aside.
In the minds of the program’s
designers, having negative equity is not an
indicator of deservedness. True, most negative
equity has arisen from broad price declines
affecting entire markets, but borrowers are not
altogether blameless. They could have made larger
down payments when they bought the house, and they
certainly did not have to take out that second
mortgage that allowed them to live (temporarily)
beyond their means.
This same mindset is evident in
the rule, incorporated in both programs, that only
occupants are eligible. Investors -- those who rent
their properties rather than occupy them -- are not
eligible. In this mindset, investors don’t deserve
help because they were implicated in the bubble that
preceded the crash, they bought houses in the hope
of turning a quick profit, and Government should
allow them to take their well-deserved lumps without
I happen to agree with that
sentiment, but in a financial crisis, deservedness
considerations are an indulgence we can’t afford.
The foreclosure of an investor-owned property puts
the same downward pressure on home prices as the
foreclosure of an owner-occupied property. Making
investors ineligible because they aren’t deserving
weakens the systemic impact of the program, which
should be its major focus.
The refinance part of the program
applies only to mortgages owned or guaranteed by
Fannie Mae or Freddie Mac.
Purpose: The objective of the
refinance program is to allow borrowers to refinance
who otherwise find it impossible or excessively
costly because of declines in the value of their
properties. Under the program, loan balances can
range up to 105% (later raised to 125%) of current property value, but in
all other respects, borrowers must meet conventional
underwriting requirements: their existing payments
must be current, they cannot have more than one
30-day late payment in the previous 12 months, and
their income must be sufficient to cover the new
Pricing: Interest rates under
the program are "market rates", but what that means
exactly is hard to say. It is not clear, for
example, whether the agencies will charge more for a
90% loan that does not have mortgage insurance than
for one that does. Whatever it means, we can be sure
that prices will fluctuate from day to day, and that
the prices loan originators quote to borrowers will
include varying markups and fees on top of the
prices at which they sell to the agencies. Markups
will be particularly high on loans held by Freddie
Mac, which will only accept loans refinanced by the
lender now servicing them.
Mortgage Insurance: An unusual
feature of the program is that any mortgage
insurance on the existing loan will be carried
forward to the new loan. (Ordinarily, mortgage
insurance is terminated when a loan is paid off and,
if required, a new policy is issued on the new
mortgage). The mortgage insurers have to agree to
this arrangement, but since it is clearly in their
interest, that should not be a problem.
This is a sensible idea, because
it prevents a sudden drop in insurance premiums to
the beleaguered mortgage insurers, and it also
provides a way to comply with the rule that any loan
acquired by Fannie or Freddie that exceeds 80% of
property value carry mortgage insurance or its
Rationale of the 105% Loan Cap:
Capping the loan balance at 105% of value presumably
is based on a judgment that borrowers with adequate
income and a good payment record are not going to
default just because they owe 5% more than their
house is worth. That makes sense. What doesn’t make
sense is that borrowers with more than 5% negative
equity are not eligible for the refinance program at
all, and can’t get their problem fixed by a loan
modification under the second part of MHA (see
Eligibility: In its
documentation, Treasury states that eligible
borrowers must occupy their homes, a provision I
criticized above. Interestingly, neither Fannie Mae
nor Freddie Mac include this limitation in their
requirements -- see the table below --
contradicting the Treasury.
Eligible structures can have up to
4 dwelling units so long as the borrower lives in
one of them.
The home can have a second
mortgage, the balance of which is not counted in the
105% cap, but the second mortgage lender has to
agree to remain in a second lien position. Some
second mortgage lenders charge a fee for stepping
aside, so this could pose a problem in some cases.
Borrowers are not allowed to
withdraw cash from the transaction, even to pay off
other debts. However, they are allowed to include
settlement costs in the new loan balance.
The two agencies have gone their
own ways in setting out eligibility rules, and there
are many differences between them. One major
difference is that Freddie Mac allows refinances
only from the existing servicers whereas Fannie Mae
will accept loans from any approved seller. On the
other hand, Fannie Mae has many more fees than
Freddie Mac. A complete list of the differences is
shown in the table below.
By far the most questionable
eligibility rule is the one that restricts the
program to borrowers whose mortgages are held by the
agencies or are in a security guaranteed by them.
Borrowers had no control over which investor ended
up with their loan, yet this crap shoot now
separates those who are and those who are not
eligible for the program. Is there a good reason for
excluding the other half of the market?
Questionable Rationale For
Limiting the Program: As noted above, the
agencies must obtain mortgage insurance on any loan
they purchase that exceeds 80% of property value.
Their regulator, the Federal Housing Finance Agency
(FHFA), has started that the agencies will be in
compliance with this rule when they refinance loans
they already own or guarantee because they are
already responsible for any default losses on these
loans, and the refinance does not increase that
risk. This rationale would not apply to loans owned
by other investors.
However, the agency would also be
in compliance with the 80% rule if it purchased
loans held by other investors that now carry
mortgage insurance that the insurer has agreed to
transfer to the refinanced loan. This is true as
well of loans that originally met the 80% rule and
still do. In a financial crisis, the net should be
as wide as possible.
Like the refinance program, the
loan modification part of MHA ignores negative
equity and offers help only to owner-occupants.
Investors are not eligible. Those negatives aside,
the modification program is well designed. Its
architects have taken note of a number of problems
that have bedeviled existing modification programs,
and have fashioned sensible remedies to deal with
Shortages of Trained Staff:
The shortage of qualified staff by servicers, as
well as the high cost of modifying loans, has
resulted in many needless foreclosures that timely
modifications could have prevented. The MHA remedy
is to provide financial incentives to servicers to
do more modifications.
Under the program, servicers are
paid $1,000 for each eligible loan they modify,
provided that the modified loan remains current
through a trial period of at least 90 days. In
addition, the servicer collects $1,000 a year for 3
years if the borrower stays current for that period.
High Incidence of Redefault:
In the past, many borrowers with modified loans have
subsequently defaulted. Many early modifications,
however, did not reduce the borrower’s payment, and
in some cases the payment increased.
Under MHA, the interest rate is
reduced to a level where payments for principal,
interest, taxes and insurance comprise no more than
31% of the borrower’s gross income. In addition, a
borrower who stays current will receive $1,000 a
year for up to 5 years in the form of balance
Restriction to Borrowers in
Default: For the most part, servicers have
limited modifications to borrowers who are two or
more payments behind. This rule assured compliance
with investor requirements that modifications were
allowed only to avoid more costly foreclosures, and
it also helped servicers allocate their limited
staff to the most urgent situations. But it had the
unfortunate effect of encouraging borrowers to
default so they could get help.
The new program attempts to remedy
this by establishing a "hardship" criteria for
eligibility that does not require the borrower to be
in default in order to qualify for a modification.
In addition, bonuses of $1500 to the investor and
$500 to the servicer are offered for each
modification that is executed while the borrower
facing hardship is still in good standing.
Multiplicity of Modification
Standards: Different servicers have applied
different standards to the modification process,
both in terms of assessing eligibility and in
establishing the type and scope of modification. The
result has been vastly different treatment of
borrowers, depending on who happened to be servicing
their loan. The new program attempts to remedy this
by setting out standards for determining
eligibility, the type and amount of assistance
provided, the documentation required, and other
In brief, eligible borrowers must
be able to document financial hardship, defined as a
monthly housing expense (mortgage payment on the
first mortgage plus taxes and insurance) in excess
of 31% of gross income. If borrowers who qualify
under this rule have a total expense ratio, which
includes all other debt payments, of 55% or more,
they must agree to obtain counseling. The mortgage
payment of eligible borrowers is reduced to 31%
primarily through temporary interest rate
reductions, following procedures detailed by the
Unfortunately, on modifications
that are not MHA eligible, the multiplicity of
standards will remain. Further, MHA rules do not
supersede investor rules if there is a conflict
The Second Mortgage Problem:
Second mortgages are a potential barrier to
modifying first mortgages because of the threat that
the second mortgage lender can always foreclosure if
the second mortgage payment is not made. Some
servicers work with second mortgage lenders, while
others require that the borrower make a deal with
the second mortgage lender that gets them out of the
In the first phase of the program,
Treasury stated that "incentives will be provided to
extinguish junior liens on homes with first liens
that are modified under the program". On April 28,
2009, they announced the details of such a program.
In brief, the Government will share the cost of
reducing the rate on seconds to 1% (2% on
interest-only loans), or of extinguishing the second
through a lump sum payment to the investor. The
details are at
Fact Sheet on Second Mortgages.
Conforming Loan Refinance Program: Key Distinctions
between Fannie Mae and Freddie Mac
Revised June 23, 2009
- Settlements on or after April 1,
- Mortgage note dates must be on or
before June 10, 2010.
- Some new features become effective
Sept. 1, 2009
- Same as Freddie Mac.
- Some new features become effective
July 1, 2009.
(Refinance must result in
one or more.)
- Interest rate reduction;
- Replacement of an ARM, I/O mortgage,
or a balloon/reset mortgage with a
fixed-rate, fully amortizing mortgage;
- Amortization term reduction.
- Reduced monthly mortgage principal
and interest payment; or
- A more stable mortgage product.
Existing Mortgage Product
All loans that are
first-lien, conventional, eligible for
purchase by Freddie Mac.
- No credit enhancements-with the
exception of borrower paid MI.
- No Alt A.
- Must be fully documented.
- No reverse mortgage loans.
- No second mortgage loans.
- No government mortgage loans.
New Mortgage Terms
40-year loans not permitted.
- 40-year loans permitted.
- No temporary interest buydowns as of
Loan must have existed for
at least 3 months.
No seasoning requirement.
- Market Condition Fee.
- High LTV fee.
- Secondary Financing Fee.
- A-Minus fee (if not same servicer).
- Total fees are capped at 2 percent.
- Adverse Market Fee.
- Indicator Score/LTV fee.
- Loan Characteristic Fee (Condo,
- No Expanded Approval Fee for DU Refi
Plus loans with an Expanded Approval
recommendation (effective July 1).
- Total fees are capped at 2 percent
(effective July 1).
- Secondary Financing Fee.
- (See matrix at efanniemae.com.)
Closing Costs/ Cash Back
- Permits financing up to $2,500 in
- No rounding cash back.
Effective Sept. 1:
- Financing up to 4 percent of new
loan amount or $5,000 of closing costs.
- Cash back to borrower may not exceed
- Permits financing eligible financing
- Lesser of 2 percent or $2,000 cash
- Minimal cash back for rounding.
- Effective July 1, 2009, cash back to
borrower may not exceed $250.
Reps and Warrants
Home valuation rep/warrant
waived if Freddie Mac’s automated valuation
model is used.
- Revised rep/warrant for properties
in areas hit by a natural disaster.
- Lenders rep/warrant new loan on DU
- Lenders also rep/warrant original
loan for Refi Plus if borrower has not
made 12 payments.
Eligible Lender Participants
- Currently must be the existing
servicer of the Freddie Mac loan.
- Same servicer requirement will be
eliminated on a date to be determined.
Any Fannie Mae-approved
seller may refinance the existing Fannie Mae
Eligible Mortgage Products
- Conventional 15-, 20- or 30-
year-fixed-rate, fully amortizing
- Conventional non-convertible 5/1,
7/1 or 10/1 fully amortizing ARM.
Fully-amortizing fixed rate
mortgages with terms of up to 40 years.
Eligible Property Types
- Single family (1-4 units) primary
- Second home.
- Single family (1-4 units) investment
Same as Freddie
Maximum Loan to Value Ratio
Same as Freddie Mac.
Mortgage Insurance (MI)
For an LTV greater than 80
- If the mortgage currently has MI
coverage, then same coverage must be
- If mortgage does not have MI, then
no coverage is required.
- For new refinance with LTV greater
than 80 percent, MI may or may not be
required depending on current coverage.
- For new refinance with LTV less than
80 percent do not require MI.
- Must be manually underwritten.
- Re-underwriting not required if
payments increase by 20 percent or less.
- Permits manual or automatic
- DU Refi Plus –DTI limits apply.
- Refi Plus – No DTI limits.
- Cannot add borrowers.
- Can delete borrowers.
- Can add borrowers.
- Can delete borrowers.
Source: Mortgage Bankers