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Let's Help Reporters Understand What 'Mortgage Refinancing' Is, Shall We?

Shaun Donovan

First Posted: 02/ 2/2012 1:02 pm Updated: 02/ 2/2012 1:02 pm

Dave Dayen today flags an exchange between Fox News White House Correspondent Ed Henry and HUD Secretary Shaun Donovan, in which the former drives the latter to distraction in a discussion over the White House's new plan to allow certain struggling homeowners refinance their homes in order to help them save some scratch. The vagaries of home loans seem to elude Henry, but from what I know of the White House Press Corps' skill set, I imagine that there are many more of Henry's colleagues who are similarly asea. So let's learn together, shall we?

What the Obama administration wants to do is help current mortgage holders who are upside-down on their mortgages (they owe more than their property is currently worth) reduce their monthly payments and stay in their homes, in the hope that this will stem the tide of foreclosures and soften the real estate market's slide to the bottom. Right now, these mortgage holders are locked into interest rates that could be reduced if they were allowed to refinance their loan at the lower interest rates that are available today. The problem here is one of access -- many of these homeowners are locked out of obtaining refi loans. What the Obama administration seeks to do is allow these homeowners to get around these barriers, provided they have been reliably making payments and their credit scores are above 580.

Okay, let's go to the Henry-Donovan colloquy:

Q: Just a quick — you were saying at the top that basically to make the President’s plan work you’re going to tell financial institutions that they can’t say no to refinancing. How do you actually — how does the federal government tell private institutions, you can’t say no?

SECRETARY DONOVAN: You misunderstood.

Q: Okay.

All right, so first off, the federal government isn't really going to have to force financial institutions to do anything they don't already want to do. See, "refinancing" is just a fancy way of saying "paying off your old loan with a new loan." You took out a mortgage in 2007, and instead of paying it off month by month, you decide you want to pay it off all at once. So you go to a new bank, borrow a gob of money, and use that money to pay off your old loan. The federal government doesn't "force" anybody to "do" anything. The old bank says, "Oh, look! Here is all the money you owe me! I will take that, thank you very much." The new bank, which has just obtained a new reliable customer that pays off her loans, says, "Oh, terrific! Some new money for me!"

You, the customer, are pleased because your new loan has a lower interest rate than your old one had. "Swell," you say. "I don't piss away as much money every month!"

Now here's an important part! The sorts of mortgage loans we're talking about are "prepayable." This means that the mortgage holder, right now, can pay off the whole nut if they had access to the money to do so. (Typically, without incurring a penalty -- this will be spelled out in the mortgage contract.) That's something that Donovan takes the next couple of minutes endeavoring to explain:

SECRETARY DONOVAN: Single-family loans in this country are prepayable, so any homeowner already has the right, even if they’re — if you owe $300,000 on your house and it’s a $250,000 house and you have $300,000, you can go and pay off your mortgage today — right? The issue is they can’t get a new $300,000 loan.

So what this plan would do, the way it breaks through this barrier for these families is to allow them to refinance that loan, to get a new loan that allows them to pay off their existing loan. There’s nothing the existing lender can do today — we’re not changing this at all — the existing lender today can’t stand in the way of a family paying off their existing loan.

Right. Like I said, if the existing lender somehow refused to allow someone to pay off their loan, that would be called "making it weird."

Q: You’re saying if they have $300,000 laying around to pay it off — or how do they do that? I don’t understand.

SECRETARY DONOVAN: They’re going to go get a new loan, and that new loan for –

Q: — the lender is okay with that, is just going to say, this is the rate you’re at right now, it’s fine if you just want to change it?

Not only is the new lender going to be "okay with that," they will use the lower interest rate as a means to attract your business and make money. This is how "refinancing a loan" works. (Also, the customer doesn't "change" the interest rate. It would be awesome if the customer somehow had this power, but that is not how "interest rates" work. What the customer is doing in this arrangement is benefitting from the offer of a lower interest rate that the refi bank is making because it gives them a competitive advantage over the original lender, who lent the money when rates were higher.)

Since lots of banks sell their mortgages to the government, it turns out that Fannie Mae, Freddie Mac and the Federal Housing Administration are currently acting as the "old bank." And Donovan's new program just means the government will allow a broader class of the loans on its books to be paid off. And the government will encourage this by telling all the "new banks" out there that if their customers don't pay back their loans, the government will shield the bank from losses.

This is how the vast majority of the housing market has worked for decades. All Donovan wants to do is let more borrowers do this -- specifically, borrowers whose home values are now lower than the loan they took out during the housing bubble.

Now, if you want to put Donovan through his paces on this policy, there are some avenues of questioning that are open to you. For starters, the incentive for refi lenders here is the loan guarantees. They are great as long as these homeowners maintain their ability to keep making their monthly payments faithfully. But if the economy craps the bed again, or the unemployment crisis ramps up, they could become very fragile, very quickly. Additionally, Republicans in the House and Senate complain that this program amounts to a new spending program, and that the Obama administration has already tried a bunch of different things to help struggling homeowners and none of them have been terribly effective.

Finally, while this refi plan is a modest goal that will save some mortgage holders a few thousand dollars in paying off their existing mortgage, it doesn't alter the larger problem -- these homeowners are still under water, chucking their income into a sinkhole. So, in many instances, it still might be smarter for these homeowners to simply strategically default.

But anyway, this is how "loans" work, Ed Henry.

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