No Free Ride for Risky Borrowers

The government's condition-laden plan to aid at-risk borrowers makes it clear: This won't be a free ride.

WASHINGTON -- After six months of haggling and political gamesmanship, a massive housing-relief bill is heading for final approval.

Though it has hundreds of pages and dozens of separate initiatives -- including revamping federal oversight of mortgage giants Fannie Mae and Freddie Mac -- the centerpiece is a $300-billion HOPE program designed to provide refinancing lifelines to as many as 400,000 homeowners in deep trouble on their current loans.

But what are the specifics? Who will be able to qualify for help? How quickly will HOPE be up and running, and how long will it run? Are there any key drawbacks or limitations?

Here's a quick overview:

• Congress' basic idea is to save people on the edge of the waterfall: families and individuals at immediate risk of losing their homes, but who could avoid foreclosure if their mortgage balances and interest rates were significantly reduced.
• The program will be entirely voluntary -- and that's a crucial limitation. Lenders and investors who own defaulting mortgages cannot be compelled to allow their borrowers to refinance. If they conclude that they're likely to lose less by allowing delinquent borrowers to go to foreclosure rather than refinance into HOPE loans, they'll be free to do so, even if their borrowers want to participate and qualify.
• Lenders will have to agree to substantial write-downs of principal and penalty fees currently owed to them. The new maximum HOPE loan amount -- insured by the Federal Housing Administration under a special new fund created by the legislation -- will be 90% of the current market value of the property, not the value of the house when the lender originally made the loan.
• Plus, the FHA will impose an upfront insurance fee of 3% of the new loan amount, payable out of refinancing proceeds that would otherwise go to the original lender. Lenders also will have to clear away any potential issues with holders of second liens on properties -- typically banks who've extended equity credit lines or second mortgages and have a claim on any refinancing proceeds -- before participating in the HOPE plan.

There are important hurdles borrowers must get over to qualify as well. They must:

• Demonstrate a "lack of capacity" to pay their current mortgage but have enough income to make regular monthly payments on a smaller, fixed-rate FHA loan. Their current income-to-mortgage debt ratio must be above 35%.
• Certify to the government that they haven't "intentionally defaulted" on their current mortgage or on any other debt in order to refinance through a HOPE loan. They also must certify that they are telling the truth about all aspects of their financial status and that they have never been convicted of a fraud. Anyone who lies on their application will be subject to severe penalties, including prison sentences of up to five years.
• Agree to use and occupy the refinanced house as their principal residence, and not own any additional houses.

An important and somewhat unusual feature of the program is the federal government's requirement that homeowner beneficiaries share any appreciation profits or equity gains from sales of their houses in subsequent years. The message here is that HOPE is no free ride. The refinancing process will essentially create new equity stakes for borrowers, because the maximum loan amount will be 90% of the appraised market value of the property.

Borrowers who had been underwater and in serious default will find themselves with 10% equity stakes overnight. But they won't be able to tap that money quickly.

If the home is sold in the first year after the refinancing, the FHA must be repaid the equity created in full. In sales occurring the next four years, homeowners can retain rising percentages of the equity, up to 50%. In addition, the FHA will be entitled to 50% of any appreciation in market value of the house from the date of refinancing to a subsequent sale.Under the legislation, the HOPE program could start as early as Oct. 1, but must end Sept. 30, 2011. Questions hovering over the entire HOPE concept include: Will enough lenders and investors agree to take the upfront losses -- they call them "haircuts" -- required to participate? Congressional estimates suggest that up to 400,000 financially distressed borrowers could be assisted, but nobody knows for sure.

Also, will lenders send only the dregs of their portfolios -- borrowers with the least likelihood of success -- to the FHA? If so, could the program end up being far more costly than Congress anticipated, even with a $300-billion authorization to cover insurance losses?