A entirely new approach to FHA financing has just been introduced by Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee.

The Frank measure, H.R. 5830 contains a provision rarely seen in a federal program.

According to the official summary of the bill, which is reproduced in full below, it says that:

“to reduce costs to the government -– and avoid inappropriate enrichment to the borrower — the government will retain a share of the borrower’s future profits. When the borrower sells the home or refinances the loan, the borrower will pay from any profits the higher of (1) an ongoing exit fee equal to 3 percent of the original FHA loan balance; or (2) a declining percentage of any profits (e.g., from 100 percent in year one to 20 percent in year five and 0 thereafter). After year five only the 3 percent exit fee will apply.”

In effect, the program would not only charge interest, it would also give the government an equity interest in the property — federal equity sharing would be a by-product of the program.

Is this good or bad? State mortgage programs for first-time buyers often have an equity-sharing feature to prevent quick re-sales. The Frank proposal would always require the payment of at least a 3-percent fee.

Thus if a home is bought for $300,000 and sold ten years later for $500,000, the fee would be $15,000 — that’s 3 percent of the sale price but 5 percent of the original purchase price.

The Frank proposal has important limits on lender penalties and would effectively require some lenders to take a loss on current loans. Such losses, however, might be smaller than the losses which would be generated by foreclosures.

Frank gets points for something new and original. It will be interesting to see how much of the proposed legislation, if any, actually becomes law.

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Summary of the Expanded FHA Refinance Program.

This voluntary program would permit FHA to provide up to $300 billion in new guarantees to help refinance at-risk borrowers into viable mortgages. This $300 billion is the total amount of outstanding loans that may be insured under the program. The government would only have liability if a borrower defaults and the amount recovered in foreclosure is below the outstanding principal. CBO is currently reviewing the proposal and their preliminary estimates are government losses between 1 and 2 percent of this $300 billion authorization.

In exchange for the acceptance of a substantial write-down of principal, the existing lender or mortgage holder who chooses to participate would receive a “short payment” (i.e. a payment for less than the outstanding balance as payment in full) from the proceeds of a new FHA-guaranteed loan if the new loan would have terms that the borrower can reasonably be expected to pay and the borrower agrees to share future home appreciation with the government. In short, the program would provide refinancing assistance to allow families to stay in their homes, protect neighborhoods and help stabilize the housing market.

Under the program, a borrower or existing loan servicer of an eligible loan would contact an FHA-approved lender, who would determine the size of a loan that would be consistent with the requirements of the program and that the borrower could reasonably repay. If the current lender or mortgage holder agrees to a write-down that is sufficient to meet the requirements of the program and make the new loan affordable, the FHA-lender will pay off the discounted existing mortgage.

In addition to a first lien, the government will retain a share of future home-price appreciation to help defray the government’s costs and prevent unjust enrichment (e.g., borrower flipping). When the borrower sells the home or refinances the loan, the borrower will pay from any profits the higher of (1) an ongoing exit fee equal to 3 percent of the original FHA loan balance; or (2) a declining percentage of any profits (e.g., from 100 percent in year one to 20 percent in year five and 0 thereafter). After year five only the 3 percent exit fee will apply from borrower profits.

Eligibility Requirements for Existing Loans (Requires All of the Following):

___Owner-occupied principal residences only (no investors, speculators or second homes);

___Existing senior loan being refinanced must have been originated on or before December 31, 2007;

___To remove any incentive for borrowers to “purposely default,” the borrower must have had a mortgage debt-to-income ratio of no less that 35 percent as of March 1, 2008, and must certify that he/she has not intentionally defaulted on existing mortgage(s);

___Participating mortgage holders/investors must waive any penalties or fees on the existing mortgage and must accept proceeds of the new loan as payment in full; and

___Existing mortgage holders/investors must accept their losses – taking substantial write-downs sufficient to: (1) establish a 3 percent loan loss reserve for the FHA; (2) pay the origination and closing costs for the new loan up to 2 percent; and (3) bring the loan-to-value ratio on the new FHA-guaranteed loan down to no greater than 90 percent of property’s current appraised value, resulting in a substantial reduction in debt service to the borrower. Accordingly, to qualify mortgage holders would need to accept a substantial write-down, accepting as payment in full no more than 85 percent of the property’s current appraised value.

Requirements for New FHA-Insured Loans:

___New FHA loans must be properly underwritten and must be based on current appraised value of the house and borrower’s documented income (borrowers with higher – but not disqualifying – debt levels would need to make six months of timely payments at the new payment level to qualify for the guarantee);

___New FHA loan must extinguish all existing liens and substantially reduce the borrower’s mortgage debt service;

___New FHA loans under this program must be within the FHA loan limits now in effect under the stimulus for the duration of this program;

___Oversight Board will set reasonable limits on loan fees and interest rates; and

___To reduce costs to the government – and avoid inappropriate enrichment to the borrower — the government will retain a share of the borrower’s future profits. When the borrower sells the home or refinances the loan, the borrower will pay from any profits the higher of (1) an ongoing exit fee equal to 3 percent of the original FHA loan balance; or (2) a declining percentage of any profits (e.g., from 100 percent in year one to 20 percent in year five and 0 thereafter). After year five only the 3 percent exit fee will apply.

Oversight Board. The program will be overseen by a “Refinance Program Oversight Board” consisting of the Secretary of Treasury, the Secretary of HUD, and Chairman of the Federal Reserve.

Coordination of Existing Lien-Holders. The Oversight Board will be authorized to take action to facilitate coordination among different existing lien-holders; and shall be empowered to establish a formula for compensating and a mechanism for obtaining the voluntary waiver of all lien holders.

Separate FHA Fund. To protect the FHA Mutual Mortgage Insurance Fund, these new loans will exist in a separate fund in FHA – and will be permitted to be resold through GNMA.

Improving FHA Capacity. The Oversight Board will take actions as necessary to increase FHA’s capacity, including:

___Treasury, Federal Reserve and HUD may sharing employees to improve FHA capacity;

___Contracting for the establishment of underwriting criteria, pricing standards, and other factors relating to eligibility;

___Contracting for independent quality reviews of the underwriting of these mortgages; and

___Increasing HUD personnel.

Auction or Bulk Refinance Study. The Federal Reserve Board will be required to conduct a study of the need for, and efficacy of, an auction or bulk refinancing mechanism and submit a report to Congress within 60 days of enactment.

Increased Fraud Prevention/Oversight.

___Independent quality reviews will be established to determine underwriter compliance, and rates of delinquency, claims and losses;

___Monthly reports will be submitted to Congress; and

___Annual audit of the program will be conducted.

Sunset. The program will run for 2 years (with flexibility for additional 6 month extensions not to exceed 2 more years).

Authorization for Foreclosure Counseling & Legal Aid. The bill would authorize $200 million dollars for foreclosure counseling, with at least $30 million targeted to low-income and minority homeowners and $30 million to assist with legal aid.

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