FHA short refinance causes no ripples

by Peter G. Miller
December 29th, 2010

It must have seemed like a good idea at the time, an effort by HUD to help underwater homeowners. But between September and the end of November the FHA short refinance program has generated just 61 applications and a single approval.

You can’t begin to imagine that such inactivity is the by-product of public disinterest. Hordes of people would like to refinance to a new FHA home loan at today’s interest rates. And while they may have the income and credit the hurdle which cannot be breached is a lack of equity to justify the loan, a hurdle the FHA short refinance program was designed to topple.

“We’re throwing a life line out to those families who are current on their mortgage and are experiencing financial hardships because property values in their community have declined,” said FHA Commissioner David H. Stevens back in August. “This is another tool to help overcome the negative equity problem facing many responsible homeowners who are looking to refinance into a safer, more secure mortgage product.”

So what happened?

You have to give HUD credit for at least making an effort to help underwater borrowers. But despite good intentions, you could see this program would go nowhere from day one.

Essentially, the idea was to help homeowners who were current on their loans and had a credit score of 500 or above. Investors — as usual — were excluded.

Under the FHA short refi plan lenders would drop loan balances by at least 10 percent. The loan-to-value ratio would be not more than 97.75 percent of the property’s current value if there was a single loan against the property; if there were two mortgages the loan amount could not total more than 115 percent of the property’s value.

So, let’s say someone bought a $300,000 home with an 80 percent first loan ($240,000) and a 15 percent second ($45,000). Today the value of the property is $240,000. Under the FHA loan plan to refinance the first lender would have to give up $24,000 in principal so the loan balance could not be more than $216,000. The maximum loan balance would be 115 percent of the property’s current value or $276,000. In effect, the second loan holder would not have to reduce the loan balance in this example.

Given the cost of short sales and foreclosures you might think that lenders would be elated to go along with this deal. But whoops, under the FHA short refinance program borrowers must be current.

In effect, the FHA program asks first lenders to give up 10 percent of the principal balance for performing loans and in some cases asks nothing of second — and more risky — second loans. Are you kidding? Why should a lender volunteer to take a loss on a performing debt?

To this point one lonely lender has bought into the FHA short refinance plan. I’m amazed the total is so high.

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