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New FHA Modification Rules Not Tough Enough

by Peter G. Miller
September 29th, 2009

Imagine that you have an FHA loan and would like to get a loan modification. You’re nearby happy lender offers you a rate which is less than what you are paying today, so your monthly costs will go down and that sounds pretty good.However, the problem here is that while monthly costs go down, they may not go down as much as they could given current loan rates. In other words, the lender is selling a loan at an above-market price.

The FHA has now come out with a new FHA mortgage modification rule which says that when FHA loans are modified the new rate cannot be more than a half percent (50 basis points) higher than the current mortgage rate.
For instance, let’s say your current rate is 7 percent. Your lender might offer you 6.5 percent or 6 percent — these are lower and better rates. But the FHA says that beginning October 23rd the lender may have to do better.

As an example, imagine that the most recent Freddie Mac Weekly Primary Mortgage Market Survey Rate for 30-year fixed rate conforming mortgages (the US average) as of the Modification date is 5.04 percent. In this case under the new rule the new maximum mortgage rate could not be more than 5.50 percent. This is the Freddie Mac US average rate of 5.04 percent rounded to the nearest eight of a percent plus 50 basis points.

You can see that the new FHA standard prevents borrowers from paying too much when their loans are modified. However, the new rule does not go far enough.

To understand the problem, go back to those additional 50 basis points. A “basis point” is equal to 1/100th of a percent, so 50 basis points is an extra half point tacked onto the interest rate.

If this a lot of money? You bet.

In rough terms imagine that you modify a loan with a $200,000 mortgage balance. If you raise the rate by 50 basis point your annual costs increases by roughly $1,000 during year one — that’s an extra $83.33 a month. Over a decade you’ll pay somewhat less than $10,000 for that additional 50 basis points.

Why should lenders be allowed to collect so much additional interest? The weekly rates posted by Freddie Mac show market-level rates — these are rates at which lenders are making a profit in the free market, otherwise they would not offer such loans. The extra 50 basis points allowed by the FHA is nothing but excess profit.

It could be argued that the additional 50 basis points are designed to encourage lenders to lower borrower costs. But lenders are already making a profit by making loans at market rates. The additional interest now legitimized by the FHA resolves the problem of gross over-charges but still saddles the borrower with rates which are not justified in the marketplace.

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