FHA Refines 'Short' Refis; Expectations Remain Low

The Federal Housing Administration's third program in two years to help troubled borrowers refinance into more affordable mortgages is likely to do better than its predecessors — but that is a low bar to set.

The agency estimates the new program could help as many as 1.5 million people who are current on their mortgages but owe more than their homes are worth. Analysts say participation is likelier to be a low six-figure number. Either showing would beat the earlier programs: FHASecure assisted fewer than 1,000 borrowers; Help for Homeowners aided fewer than 100.

But even the government's rosier estimate is a drop in the bucket compared to the 11.2 million borrowers, or 24% of homeowners, who had negative equity at the end of the first quarter, according to CoreLogic.

"It serves a narrow band of homeowners who have done the right thing by continuing to pay their mortgage," said James Deitch, the chief operating officer of the $1.1 billion-asset First Chester County Corp. in West Chester, Pa., and managing director of its American Home Bank mortgage division.

The FHA, which released details of the program last week, eased some of the tough eligibility requirements and removed some of the complexity that had hampered predecessors. Experts said the program will entice some special servicers and banks that have loans on their balance sheets and want to refinance into a government-insured loan. Nevertheless, the program faces an uphill battle in getting second-lien holders to agree to take lumps.

Servicers would have to write down a loan by at least 10%. Unlike H4H and FHASecure, which were designed to help delinquent borrowers, the new program is available only to homeowners who are current on their mortgages.

The new program requires that the first lien be written down to 97.75% of the home's current value before being refinanced in what insiders often call a "short refi."

If there is a second lien, the combined loan-to-value after refinancing can be no greater than 115%. But analysts said the program's incentives for second-lien holders to forgive principal — $500 plus 10 to 21 cents per dollar of debt extinguished — probably are not large enough since most banks make more money collecting interest until the borrower defaults.

The new program does allow for a FICO score — 500, versus none in Hope for Homeowners — and a higher total debt-to-income ratio — 50%, compared to 38% in H4H and 43% in FHASecure. But just as in those earlier programs, the homeowner's total monthly mortgage payment cannot be greater than 31% of his or her gross monthly income.

Sandeep Bordia, the head of residential and commercial credit strategy at Barclays Capital, said that, like other refi programs, the new one will be hobbled because of problems with second liens.

The new program does give servicers a safe harbor from being sued by investors for writing down principal. Fear of such liability crippled H4H.

"They've tried to take care of some of the issues in previous programs, which were complete failures," Bordia said. The problem is that most borrowers have high loan-to-value ratios, "so to get the borrower all the way [down] to 115%, will be pretty hard and will need some reduction of the second lien," Bordia said.

H4H created too much complexity because lienholders, including the second mortgage holder, shared in the home's future appreciation. The program's FICO requirement of 580 and lower back-end debt ratio of 38% disqualified many borrowers.

FHASecure required lenders to write down the loan to 90% or 97% of the home's appraised value, depending on how long the loan had been delinquent — a bigger hit than in the new program.

Jonathan Foxx, the president and managing director of Lenders Compliance Group, a Long Beach, N.Y., compliance and analytics company, said the long list of eligibility requirements could doom this program as well. "You have a small percentage of homeowners and, even if they qualify, will not get the buy-in from the lenders," he said.

Anthony Hsieh, the founder and chief executive of loanDepot.com, an Irvine, Calif., online lender, said most servicers and banks have refused to offer principal reductions at all — and rarely to borrowers who are current and able to pay.

"The borrower is going to want this product, but the borrower is not the decision-maker on this product, the lender is," Hsieh said. "Would a bank approve a short sale if the borrower is current, they want a discount of their principal, and if they have 31% DTI? I don't think so."

Bert Ely, an independent analyst in Alexandria, Va., speculated that the program would offer a second shot at principal reduction for borrowers whose loans were modified but only with a lower interest rate. So far, 398,000 borrowers have received permanent loan mods through the Home Affordable Modification Program.

The new FHA program "appears to be an attempt to salvage mods that have a potential to redefault," Ely said.

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