This morning President Bush signed into law the American Rescue and Foreclosure Prevention Act of 2008 -- our Government's attempt to address the housing and credit crisis.
The centerpiece of the new law is a $300 billion authorization to the Federal Housing Authority (FHA) to guarantee new first mortgage loans if and when: (i) an existing lender agrees to reduce principal to 85% of the appraised value of a house, and (ii) an existing borrower can qualify for a new 30-year fixed-rate loan. The intent of this provision is to provide needed debt capital (attracted to the FHA guarantee) for homeowners who might otherwise be subject to foreclosure while at the same time incenting lenders to take a loss on a loan in order to avoid litigation, delay and expense. In theory, the law makes sense and I am personally in favor of anything that may stop the downward spiral in housing prices.
My anxiety, however, is whether this provision will achieve the intended results for the gap between theory and practice is where the rubber meets the road.
Here are some of my concerns:
1. Will lenders participate in this voluntary program? Presumably the lender who does participate recognizes that it has a problem loan (it is unclear to me how the law works if a borrower is already in arrears) and calculates that the refinance option (taking a hit on its debt) will achieve a greater net result than foreclosure.
2. Will appraisers be a problem? Many appraisers are skittish today about valuing homes. Let's assume that a lender has a $200,000 loan on a house it believes is worth $175,000. The lender is willing to take a hit of about $50,000 to avoid a foreclosure and since 85% of $175,000 is $148,750, the lender is willing to go the FHA refinance route, i.e. absorb a loss of $51,150. The problem is that the appraisal community -- not sure where the floor of the housing market is - may value the house at only $150,000. If so, the lender now has to take a hit of about $75,000 if it elects to participate in the refinance program.
3. Second mortgages can also be a problem. It is estimated that during the housing boom about half of subprime borrowers obtained both a first and second mortgage to consummate a house purchase. Since a new mortgage is going to have to be in first position, the existing second mortgagee (lender) has to cooperate (either by release or subordination of its position). There is nothing in the new law which forces a second mortgagee to cooperate and so this lender may be able to gridlock the process unless he gets some "going away money."
4. Can the homeowner qualify for a new fixed-rate loan? The presumption of the new law is that the homeowner seeking to refinance will underwrite for a new loan which is at least 85% of the current appraised value of his house. This may or may not be true. Remember that a sizeable number of the borrowers who obtained a mortgage within the last 48 months were qualified based on stated income ("my income is $X"), interest-only loans, and low teaser rates ... or, they weren't qualified at all, i.e. there was no regard to the ability to repay the loan. Here is an understatement: things have changed. Now borrowers have to really qualify and, in addition, the new law requires that the borrower make an annual payment to FHA equal to 1.5% of the new loan. Even with the reduction in debt, how many borrowers can qualify for the new loan?
The above questions (and others) bother me because if after all the debate and turmoil, the new law only works "on paper," a lot of people will have wasted a lot of time and effort for nothing. That having been said, I applaud the effort - it is easy to be a critic and heaven knows there are a lot of those around today. The fact is that we have serious problems and there are no easy answers. I am for trying anything that appears to make sense.