This Just In: Refinance at 125% of Market Value

Remember the Make Home Affordable program announced in February? One of the eligibility requirements was that the amount refinanced under the government program could not exceed 105% of current appraised market value.

Well, that has been changed to 125%. Go here to read the latest application questionaire, which includes the following:

4. Do you believe that the amount you owe on your first mortgage is about the same or less than the current value of your house?(Yes / No)

You may be eligible if your first mortgage does not exceed 125% of the current market value of your home. For example, if your property is worth $200,000 but you owe $250,000 or less on your first mortgage, you may be eligible. The current value of your property will be determined after you apply to refinance. If unsure, click "Yes" for Question #4 and go to Refinance next steps.

So, if you bought your home for $275,000 in 2006, and it is now worth $200,000 (decline of 27%), and the mortgage balance is $250,000, you may be eligible to refinance under the revised government program, provided it is an agency mortgage (Fannie or Freddie).

Bruce Krasting has an excellent discussion of this change in the Make Home Affordable program here. Another fine article is available from Edward Harrison here.

Let's look at some hypothetical case studies.

Case Study 1. The buyer got his 10% down payment from a second loan, most of which is still outstanding. His initial first mortgage is at 3% with a 5-year reset due (in 2011) to 10-year Treasury +2%. At today's rate, that would be 5.55%. Let's say the government plan would be 5.25%, slightly under the current 30-year average rate. Here are the approximate monthly payments:

The last line gives the numbers if the 10-year Treasury yield rises from the current 3.55% to 4.55%. The hypothetical rent is the average monthly rent assumed for similar housing in the area.

This buyer has essentially invested nothing in this house, would owe close to $75,000 (plus $12,000 or so in selling costs) if he were to sell, and sees an increase of $200 a month of expense if he refinances. On a purely financial basis, this individual has no incentive to refinance. He could well look at the house the same as a rental and simply walk in two years unless the reset in 2011 is much lower than we have estimated. If the $25,000 second loan is a second mortgage with no recourse, he loses nothing except some points from his credit score.

Case Study 2. This buyer took a 100% first mortgage at purchase. The discussion and data is essentially the same as Case Study 1. This case may not be as likely as Case Study 1, because only agency mortgages are eligible for this program and I am not aware that Fannie and Freddie underwrote 100% mortgages.

Case Study 3. This buyer paid 20% down ($55,000). His mortgage would have been originated around $220,000 His motivation to hold onto the house is considerably more than the previous buyers because more than 70% of the price decline for the current market has been his money. This individual will see much more financial benefit in riding out the market cycle and look forward to a future healthier market where he may again have positive equity. Even though he may not expect to see all of his $55,000 back on his personal balance sheet in the forseeable future, he may anticipate the return of market value above $220,000, at which point further gains accrue to him.

This individual is a likely candidate to refinance and is also likely to continue with the adjustable rate mortgage in 2011 under the two interest rate scenarios considered. His approximate payment matrix is as follows:

Summary. The type of buyer who would have taken an adjustable rate mortgage is much more likely to fit the description of Case 1 or Case 2. Most buyers fitting the description of the Case Study 3 individual would very likely have selected a fixed rate mortgage initially. These are likely already in a mortgage close to the government program refinance rate of 5.25%. Perhaps a few have rates near or above 6% and they could benefit from the government program, if it is in the 5 -5.25% range.

If the government program has mortgages much below current market rates (say 4.75% or 4.5%), then a few more who are underwater in the adjustable rate pool could benefit. Even in that case, I believe the bulk of the people in the situations described in Case Studies 1 and 2 would not benefit and would not apply, even if some of them could qualify. If the amount of required payment exceeds the cost of rent by a couple of hundred dollars or more, and is going toward something that is underwater by $75,000 to $90,000 if sold, most will walk. They probably have never had a net worth anywhere near that amount. It will look like a fortune to them.

The change from 105% to 125% of market value available for refinancing will help prevent a few foreclosures that would otherwise occur in the 2010 - 2012 adjustable mortgage reset pool.. However, it is likely to be in the noise level.

Comments

[Steven Hansen:]

all this works of course if the housing decline ends and houses start a climb back up.

i do not think this will happen in general, and most of these refi's will also eventually fail.

as the housing decline is inconsistent throughout the country, there might be some areas this kind of program will work.

Jul 05 07:34 PM

[Carlos Lam:]

Great! Now, in addition to dangling an $8,000 tax credit so that first-time homebuyers (i.e. anybody who hasn't owned a home in 3 years) can take on more debt, the government is pushing debt on those who will be better off financially if their loan is liquidated & they rent. I'm so glad that they're looking out for the "little guy" & encouraging him to resume over-leveraging himself.

Jul 05 09:40 PM

[Loan Survivor:]

John, you make some good points, I can tell you though, from being in the "trenches" that most people have a highly emotional attachment to their homes. They won't follow the rational logic of your argument and will go pretty far to try to save their homes.

In reality, it all boils down to can they afford the payment. If they can't, they can always go for the modification part of Obama's housing intitiative.

Jul 06 07:35 AM

[RateNerd:]

125% mortgages went away in the late '90's - early '00's because they were dumb loans. So now the government is encouraging people to trade in their dumb neg-am loans for dumb 125% loans. When is someone going to realize that the cycle needs to end and stop lending money to people who cant manage their finances?

Jul 09 08:32 AM