Banks Embrace FHA Short Refi Program As Lawmakers Target It
Big banks and Washington aren't on the same page — again.
Though lenders have long resisted entreaties to lower principal for underwater borrowers, Wells Fargo & Co. and Ally Financial Inc., formerly GMAC Inc., are poised to roll out pilots that would let such borrowers refinance into Federal Housing Administration loans and would write down the value of the credits.
But the decision coincides with House Republican efforts to eliminate the FHA Short Refi program that the pilots would rely on.
FHA Commissioner Dave Stevens has been pressuring big banks to adopt the Short Refi program because more than 20% of all homeowners have negative equity, where the value of the house is lower than the balance of the mortgage. Negative equity makes it difficult to modify or restructure a loan and has been a significant factor driving foreclosures.
A key obstacle for lenders has been the requirement to write down a loan by at least 10% and ensure that the total loan-to-value ratio is not greater than 115% after refinancing. To qualify, homeowners have to be current and must meet FHA underwriting guidelines.
Banks and investors generally have been opposed to cutting principal particularly for borrowers who are currently paying their mortgage.
"Without question the FHA Short Refi program has been a difficult one to get off the ground," Stevens told a House subcommittee Feb. 16.
At the hearing, Stevens said two large banks were "building up the capability to be able to roll out the program," which requires an investment in technology and systems.
"We believe that principal writedown is absolutely needed, it's one of those key remaining variables left to address outside of modifications to get this economy — this housing economy — right-sized," Stevens said.
Wells Fargo confirmed Friday it is currently working on a pilot of the FHA program for loans in its own held-for-investment portfolio. That way it would take a hit to its own balance sheet if it reduced principal for borrowers, said Tom Goyda, a Wells spokesman.
Goyda cautioned that "principal forgiveness is not an across-the-board solution," and is best used for borrowers in geographic areas with severe price declines "where there is little prospect for a full recovery of home values."
"Not every homeowner with a loan balance that exceeds the value of their home falls behind in their payments," Goyda said. "Payment affordability continues to be the key."
In the meantime, opposition to such programs on Capitol Hill has gained steam.
House Financial Services Committee Chairman Spencer Bachus said he wants to eliminate four foreclosure-prevention programs including the Short Refi and Home Affordable Modification Program programs.
"In an era of record-breaking deficits, it's time to pull the plug on these programs that are actually doing more harm than good for struggling homeowners," Bachus said.
Just 182 borrowers have refinanced using the Short Refi program, which was started a year ago.
Another obstacle is that Fannie Mae and Freddie Mac, which control nearly half of the loans serviced by large banks, will not allow their loans to be refinanced through FHA. Doing so would affect the value of their performing loans and could trigger the need to draw more money from the Treasury.
Reducing principal also could prove to be a windfall for some borrowers if housing prices ultimately rebound. One reason lenders are now requiring a 20% down payment is precisely to avoid allowing borrowers to have so little equity that they cannot withstand home-price declines.
Edward DeMarco, acting director of the Federal Housing Finance Agency, the conservator of Fannie and Freddie, sent a letter to the Department of Housing and Urban Development Secretary Shawn Donovan recently saying principal reduction was not consistent with conservatorship.
Dan Frahm, a spokesman for Bank of America Corp., said its participation in the FHA program was contingent on Fannie and Freddie's.
"Given they own more than half of the loans we service, we believe only with their participation will the number of customers benefiting from the program reach critical mass," Frahm said.
Other large lenders — Citigroup Inc., and JPMorgan Chase & Co. — did not return calls seeking comment on whether they had adopted the program.
Steven Gillan, the executive director of the American Alliance of Home Modification Professionals, an Astoria, N.Y., company that helps servicers with the government's loan modification program, said it would be careless to eliminate programs and let the housing market go into free fall.
"Are we going to let 7 million houses that are currently 60 days' delinquent or in foreclosure be put on the market?" Gillan said. "We would have a 20-year recovery because all the foreclosed properties would come on the market, reducing value for everyone. It's a vicious cycle."