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This Act gives the FHA 300 billion dollars to be used between October of 2008 and September of 2011 to refinance certain loans made prior to January 1, 2008. It is intended to allow homeowners who cannot afford their present loans to refinance them through cooperating lenders and holders. This legislation has been heralded as a way for almost 400,000 homeowners to avoid foreclosure. Critics, however, have noted that the Act really will not help many who will be foreclosed upon. In truth, we believe that the Act will be of some assistance, but cannot help but comment that it, by its basic construct, is not really intended to help most of those in trouble.
To begin with, if one takes 300 billion dollars and divides it by 400,000 expected beneficiaries, that is an average loan size of $75,000 while the average mortgage in the United States is well in excess of $120,000. If that mortgage amount is used, the number of borrowers that can be helped is only 250,000. |
If there are another 2mm foreclosures over the next 3 years (which may be a low figure) that is less than 15%.
This Act gives the FHA 300 billion dollars to be used between October of 2008 and September of 2011 to refinance certain loans made prior to January 1, 2008. It is intended to allow homeowners who cannot afford their present loans to refinance them through cooperating lenders and holders. This legislation has been heralded as a way for almost 400,000 homeowners to avoid foreclosure. Critics, however, have noted that the Act really will not help many who will be foreclosed upon. In truth, we believe that the Act will be of some assistance, but cannot help but comment that it, by its basic construct, is not really intended to help most of those in trouble.
To begin with, if one takes 300 billion dollars and divides it by 400,000 expected beneficiaries, that is an average loan size of $75,000 while the average mortgage in the United States is well in excess of $120,000. If that mortgage amount is used, the number of borrowers that can be helped is only 250,000. If there are another 2mm foreclosures over the next 3 years (which may be a low figure) that is less than 15%.
This legislation, in our opinion, was a compromise with powerful banking lobbies. In most markets values have depreciated over 25% over the past 2 years. In many markets that depreciation can be as large as 40%. As will be discussed, the FHA loans cannot be in excess of 90% of today's market value. Thus, in an average market, that means that the present lender would need to forgive almost a third of the loan amount. It has been our experience that, in terms of obtaining deeds in lieu of foreclosure or short sales, lenders are anything but keen to accept losses of that amount. Lenders are under absolutely no requirement of participating in the program at all, or, if so, to any extent. That is the inherent problem with the legislation and evidences the compromise reached.
We believe that it is prudent to assume that, where depreciation has been greatest; generally where foreclosures have been greatest, holders will be unwilling to accept this level of loss. Although one can argue that this loss is still better than what they would experience in a foreclosure, it does not take into account the fact that, in a foreclosure, in most instances, the holder can still pursue the borrower for a deficiency judgment.
Some would say that holders know that they almost can never recover those judgments, and will not try to collect upon them. But, lenders may still use them as leverage to obtain some amount, at some future time. Even if the borrower declares bankruptcy seeking a wage earners Chapter 13 plan, the holder will receive a portion of that deficiency amount. Only some borrowers can obtain a release through a Chapter 7 bankruptcy. In all other instances the holder will garnish wages or attach other assets to receive some amount of the deficiency. For this, and other reasons, lenders may take their chances in a sheriff’s sale and simply foreclose.
Other proponents of the Act claim that lenders will be under enormous political pressure to allow FHA refinancing. Although only time will tell, we believe that lenders will largely "dig in their heels" when they think that they can obtain a better deal in a foreclosure.
That is the primary reason why this Act may not be beneficial to many homeowners.
Secondly, the qualifications for an FHA refinancing will disallow many to qualify.
1. The borrower must show that it cannot afford the payments today. Does that mean that, if they can get by on what is considered possible by the FHA, they do not qualify? Will the FHA assume that a family of four must live on $100 per week of groceries; or that they can sell their already financed automobile, or that they can take public transportation even when that is really not feasible? No one has those answers and our guess is that it will vary greatly and subjectively between one administrator and another.
2. The borrower must show that it presently has a ratio of mortgage related expenses to gross income of over 31%. That should not be much of a problem for most families in trouble, however, in more than a few instances, that ratio may be difficult to apply in circumstances where the borrower has variable income-for instance salespeople who have made better money in the past than they are able to make today, or in the future.
3. The borrower must be able to prove the ability to qualify for the new loan based on income that is verifiable through their tax return. While this may be fine for many homeowners, it is not the case for those whose loans were made based on "stated income" at the time of their present loan. This is where a lot of abuse took place and lenders simply "fudged" income numbers. For those in that situation, coming up with tax returns showing the amount of income today, will be very difficult.
4. If there is at present a second mortgage held by a holder other than the first mortgage, that second mortgage must be paid off. In so many instances, borrowers have second home equity or other loans with lenders other than that on the first mortgage. Almost no holder of that second mortgage will agree to simply let the borrower go without obtaining a good portion of that loan. For a huge majority of those with two mortgages, that virtually eliminates the possibility for an FHA loan under this Act.
5. The borrower must be able to put down approximately 3.2% of the new FHA loan (possibly more). Many borrowers are not in the position to do so. They may borrow from someone who is not a party to the transaction, but that loan must be entirely subordinate to the FHA mortgage, meaning that it may not be repaid before the FHA loan is. As these loans are 30 year fixed rate vehicles, that may be a long time.
6. The borrower will pay the FHA rate, considering their creditworthiness and assets. Although that rate may be 25 to 50 basis points (one one hundredth of a percent is a "basis point") less than a convention rate, that may not be the case given the bad credit of most people facing foreclosure. On top of that the borrower must pay an "insurance fee" of 1.5%. When you add that together, it may make the loan rate considerably higher than a conventional rate. Still, of course, the rate applies to a much lower principal balance, so it is still a "good deal". But, in terms of actual monthly payment, perhaps not as good as what may be obtained in a good modification.
7. If the borrower sells the home or refinances it over the five years after the FHA loan, the amount over the loan amount will be split between the FHA lender and the borrower at a rate starting at 90% to the lender and going down to 50% in year five. This is still, obviously, a good deal for the borrower.
8. The FHA program will only apply to the borrower's primary residence and not to any investment property.
9. The amount of the maximum loan is gauged to the marketplace in which the home is located which is good, in that, in high cost areas, the cap will be larger than in lesser cost areas; however, the cap in high cost areas, may still knock out many loans that are over the conventional limit for a GSE loan.
The borrower must recognize that there is a dilemma which is faced in relying upon the FHA program. From a pure negotiating standpoint, if the borrowers are dead-set upon obtaining the FHA loan, they may miss the opportunity of obtaining a modification which will keep them in their home. Some holders of the present loan may dismiss the FHA option out of hand. In that event the borrower must immediately move toward a modification. In order to push their qualification for the FHA loan, the borrowers may show that they cannot handle the present loan and detract from their ability to pay a modified loan. It is critical for a borrower to know exactly when to abandon the hope for the FHA loan and push for a modification. It is also necessary, in convincing the holder to look at the FHA loan, that they not "shoot themselves in the foot" and create a problem in asking for a modification. This is a balancing act that few borrowers and even credit counselors are able to do well.
Remember, the holder is going to look at all of its options. They can foreclose and go after the borrower for a deficiency judgment. They will weigh that against their cost of forcing a "short sale" where they may get more than the 90% of fair market value that the FHA loan provides. In fact, if a home is really worth fair market value, forcing the property to be listed for 90 or more days, may bring in a buyer that pays more to the lender. If they find a buyer for more, they will force the borrower to take the short sale. They will also look at the costs of a modification which, in many instances, is the best situation for them. That is why, we believe that the FHA program will actually help borrowers to obtain a modification that will allow them to stay in the home, more often than the actual making of the FHA loan.
At the Debt Advocacy Center we believe that our aggressive pursuit of a lender in terms of weighing the cost of a contested foreclosure (based on facts which show them that the origination of the loan may have been done improperly) will give the borrower the greatest hope of obtaining the holder's consent to the FHA program, but, if that does not make sense to them, to allow the borrower to obtain a modification that will comfortably allow the borrower to stay in the home. It is necessary to weigh all of the pros and cons of both approaches, before deciding upon a strategy for negotiation.
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