High Loan-to-Value Homeowners Can Get Refinance Help, but They Need to Shop Carefully

There is a difference between the way the political folks in Congress think the world works and what really happens where the rubber meets the road. In this case, I am talking about programs instituted under various plans designed to help the housing market recover. I'll discuss the first one here.

The first programs are designed to help people with loans with above-market interest rates and high loan-to-value percentages to refinance into lower-cost mortgages. The idea is that with the declining values in so many areas, many homes were "under water"to the point where the owners could not refinance under normal rules that require the homeowner to have equity in the property.  

The total loan-to-value that would be allowed was a generous 105 percent. This meant that if a home had a loan on it that started out at 80 percent loan-to-value (LTV), if the value went down so that the home was worth even less than the current value of the home, Fannie Mae or Freddie Mac would still do a new loan if they owned the original loan and the LTV was at 105 percent or below.

Importantly, no private mortgage insurance (PMI) would be required, even if the LTV exceeded 80 percent. If the original loan had been over 80 percent LTV so that PMI was required, the existing PMI policy would stay in effect. Theoretically, these programs allowed a lot of homeowners the opportunity to get lower rates and strengthen their financial position. That would be good for the economy.

The program was greeted with enthusiasm in the press, warmly by the public, and coldly by lenders who were slow to introduce it. The most immediate shortcoming was that a homeowner could refinance only the principal balance of the 1st mortgage Trust Deed (TD). Many people had seconds, mostly Home Equity Lines of Credit (HELOCs). Most people would have liked to combine both loans into one new one, but the program would not allow that.  

It also became clear that 105 percent LTV was on the skinny side and that there were just not that many people in that narrow niche who would benefit. So Fannie and Freddie made the program more generous, allowing loans up to 125 percent LTV.

So what happened? First, it is important to understand that everyone who originates a loan ultimately sells it to Fannie Mae or Freddie Mac, perhaps through an intermediary. I might do a loan with XYZ Mortgage Banker who would sell the loan to Citicorp who would sell it to Fannie or Freddie. All transactions are governed by contracts that obligate a lender to "buy back"a loan that was granted fraudulently. That's okay.

But with paranoia about loan quality being rampant, the contracts now contain very loose language that allows a lender to require a buy back even if there is no "good reason."You can't just tell the next guy up the chain that you won't buy the loan back. You need them, and if they cut you off, you'd be out of business.

Additionally, everyone started inserting additional quality control people into the system. It turned out that when you take a newbie, train him on some narrow aspect of the business, and put him to work on loans that have just been bought, he may find errors. I'm not talking about BIG errors, like someone started doing loans fraudulently or well outside the program parameters that would cause future losses. I'm talking about little itty-bitty clerical "failure to check the right box"errors, usually on perfectly good loans.  

We did an $180,000 loan on a $1,900,000 property, less than 10 percent LTV. That loan would NEVER go bad. In my book the "checkers"should never even look at loans like this; they should only look at loans where the possibility of actual loss is higher, like on 95 percent LTV loans, for example. But the lender kicked it back for a trivial reason that we were able to fix quickly. But had we not fixed it, there would have been a big loss.

The specter of having to buy loans back places more risk on retail lenders than they want to assume. It has led to somewhat of a paralysis in that some lenders will now no longer do loans over 80 percent LTV. Their thinking is that if they funded a loan under these expanded parameters and someone made them buy it back, they would have to have PMI on it to sell it to someone else, and you can't do this after the fact because the borrower has to pay it.

Not only that, but many of those lenders who are still willing to do 105 percent loans never picked up on the 125 percent LTV loan limit. They kept their maximum at 105 percent.  

Bottom line: This program that was supposed to help million of homeowners has actually been helping only a small fraction. It's like the other programs announced in Washington, like the loan modification programs that were abysmal failures. One was supposed to help millions but attracted fewer than 1,000 applicants during the last quarter of 2008.

My purpose in writing this is to alert homeowners to shop carefully for mortgages under these programs. You might very well meet all the program parameters, but if you go to the wrong lender, one that hasn't adopted the full program, they will tell you that you don't. Obviously, this is the first question to ask. It may also make sense to use the services of a mortgage broker who will have relationships with a number of lenders. They will know which lenders are doing what you need.

In the future, I will discuss similar problems with appraisals and disclosures, problems that are a result of the government meddling in the process with new rules that not only don't help, but that are actually harming consumers.