Refinance rules change for some underwater mortgages

[ERD50]

https://personal.vanguard.com/us/fun...FundIntExt=INT

GNMA down just 1 penny today. I wonder if this sort of refinancing is big enough to affect the fund?

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When mortgage refinance activity is high, the yield on the fund is likely to decrease.

-ERD50

[MissMolly]

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Originally Posted by Mulligan Sam, you got me thinking. When I called Wells Fargo a year ago, which my originator, I was just inquiring about a regular refi. They told me to use the HARP. I told them I thought you had to be under water, and they said no. Looking back it seems like they were eager for me to use it. I was fine with it as it was cheap and a breeze to do, but they wanted to go that way originally not me. I wonder why.

Why? Because each time a HAMP or HARP workout is made, the lender is paid an incentive payment by the Treasury department.

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Originally Posted by MichaelB These are not troubled loans and nobody is forcing banks to do anything. They are as anxious to refinance underwater mortgages as homeowners. The problem is lending rules don’t allow that in too many cases. All this does is let homeowners with negative equity have the same opportunity to refinance at a lower rate as other homeowners. Allowing people with positive equity to take advantage of lower rates but denying people with negative equity the same opportunity is not sound economic policy.

Although lenders are not "forced" to do this, Fannie/Freddie keeps scorecards on all the lenders. The lender is given a "goal" of how many workouts they are expected to complete each month. If they fail to meet their goal, they've got some explaining they have to do to Fannie/Freddie.

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Originally Posted by Texas Proud Samclem... most mortgages are in some kind of bond... sold to investors... banks do not hold them like they used to... I wonder if the bond that holds the mortgage is going to hold the new one or if they are going to pay that off and put the refi loan in another bond If they keep it in the old bond, then there is a negative interest rate impact... if they put it in a new bond, then the possibility of default has moved from one bondholder to another... I would think they would have to disclose the info on the number of mortgages that are not covered by equity in the house... or something similar... OR, maybe FM is planning on holding it without selling it to the public.... I guess details to be announced later.... Over all, I would say this is a good program... lowering payments for people who can afford to stay in their house will likely result in fewer forclosure which can only help... and I am one who thinks that nothing the gvmt does will help much until the glut of housing is removed...

They would be new loans. A lender cannot substitute a lower interest rate loan for an existing loan in a pool. The loan would have to be bought out of the pool (paid off) and then the new loan made and re-pooled.

[samclem]

The NYT has a short piece about the new program:

In part:

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The plan also seeks to encourage banks and mortgage companies to participate by eliminating their legal responsibility for problems with the original loan, a significant financial benefit in many cases.

So, the new program will let the originators off the hook for any malfeasance (charitably called "problems" above--cute) regarding the original loan. One means of "holding Wall Street accountable" are the potential civil and criminal penalties for firms that deliberately broke the law in writing bad loans (liar loans, fraudulent appraisals, etc). This new proposal closes a door by which taxpayers might recoup some of our growing losses. Another gift, from our kids.

[Tractor guy]

Actually, this may be a gift to my kids. I think they may qualify for this. They are underwater on the starter home they bought 5 years ago. If they qualify, this will allow them to lower their mortgage rate & pay down their mortgage more quickly. It will bring them to the point of being able to trade up much more quickly.

I think that this is the right thing to do. The glut of unsold houses isn't going to be flushed out of the system until people are financially sound enough to start buying again. There have to be a lot of kids out there who are at the point in life where they need a bigger house but can't afford to sell the old one. The economy isn't really going to get into gear until this changes.

Lorne

[clifp]

My initial thought was this seems like a good idea. In fact, I've suggested it in the past. Now given that modest amount of my money, and roughly 1/3 of my mother's money is invested in Vanguard GNMA fund VFIJX I wondered what the impact would be to me and mom.

However, SamClem's comments and this WSJ Editorial really caused me to rethink my position.

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The thinking is that this will reduce defaults. Or as FHFA said, "Such refinances bring benefits to borrowers, to housing markets, and to [Fannie Mae and Freddie Mac] and taxpayers." Missing from that winners' list: investors who finance housing markets by purchasing mortgage-backed bonds. They will fund this new effort. Here is how: As homeowners refinance, investors who bought mortgage bonds will be given back their money and will have little option but to reinvest at far lower yields. The transfer is the difference in yield... Granted, prepayment risk is inherent to mortgage bonds. There is also likely to be little sympathy for bondholders having to give up money to shore up housing. But that ignores that the government is picking winners and losers. Effectively, it is deciding some losses on some things are acceptable, say on 401(k) retirement plans, yet aren't on others, namely housing...

How much would this yield transfer hurt? I went back and checked, back in summer of 2007, 1 share of VFIJX was distributing .$.045 per month at share price that has been for decades $10 +/- $1 that works out to be 5.5%. Last month those same shares were distributing $.031 cents. This is a drop in income of almost 1/3. (Now it is nice that price is of VFIJX is now over $11, but pretty much irrelevant to mom and I) The impact on my mom is no different than a working family where they took paycut or saw their hours reduced. There is less money to spend.

Well ok so maybe Mom and I will need to take one for the team, cause as ERD suggests (and it was my initial thought also) the folks with underwater mortgages will spend the money stimulated the economy. Plus ultimately we do have to fix the housing crisis for their to be full recovery.

But the articled included this little tidbit.

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Another unsettling wrinkle: The FHFA is adding an incentive for borrowers to refinance into shorter-maturity mortgages. But in many cases, this will mean a borrower's monthly payment, including principal repayment, won't decline. It may actually rise. That undermines the notion that these borrowers are unable to meet monthly payments and need government assistance.

In fact virtually all of the discussion we've seen about refinancing recently (ok Nords is an exception) involved getting a shorter loan. Given that people doing the refinance are by definition current, some percentage can actually afford a higher payment. If you have 6.5% 30 year and refinance into 3.5% 15 year your payments only increase by 12%, many folks in their 40s and 50s probably are rethinking the wisdom of retiring with a mortgage.

So when we look at the whole picture this is not nearly such a great idea. The lower yields on GNMAs, means Mom and I have less money to spend. The folks who refinance to short loans also have less money to spend. So why is this a good idea again?

One interesting thing about this forum is that we are for the most part prodigious savers. As group we saved long before it became trendy to do so. . The last few years the Fed and most politicians have declared open season on savers, especially the most risk adverse (this does not include me.) As a class. we savers really have nobody speaking out for us. Yet when a proposal like this which is pretty much a direct transfer from our pockets to borrowers, we applaud it. (Except for SamClem) FYI Vanguard Total Bond fund has 30% mortgage securities so all you VBTLX holders this hurt you too. Now admittedly the impact for us savers is probably quite small maybe 10 basis (wild ass guess) but collectively it is pretty significant.

Now maybe this isn't a big enough deal to Occupy Washington over, but do we really have applaud those who are trying to reduce our income?

[Nords]

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Originally Posted by clifp Yet when a proposal like this which is pretty much a direct transfer from our pockets to borrowers, we applaud it. Now maybe this isn't a big enough deal to Occupy Washington over, but do we really have applaud those who are trying to reduce our income?

Everyone can support "give someone a break", but I'm a tad cynical about granting a for-profit agency the immunity from the felonious activity that caused us to be talking about giving someone a break.

But here's a different sort of logic that I'm seeing more frequently: might as well suffer a little now to avoid a lot of suffering later.

It started a few months ago when I wrote about a government promise that had effectively become worthless. You can offer cheap healthcare to military retirees all you want, but when the doctors won't take the government's reimbursement rates then it doesn't matter what the govt promises you.

You can offer lifetime COLA pensions to military retirees, too, but when the govt runs out of money then it doesn't matter what's been promised. The authorities may wring their hands in despair, but the fact is that the deposits stop showing up in people's checking accounts. I'm writing that post now.

Seems like a similar situation here: if you give these homeowners a break now then it'll cost you 30 cents out of your taxes. If you wait until nature takes its (seemingly inevitable) course then it'll cost you a buck in foreclosures, neighborhood declines, violence in the streets, extra police protection, doom & gloom.

However there's that nagging little detail about taking care of special interests in the name of motivating them to "do the right thing". I don't think amnesty makes them any more capable of doing the right thing next time home values take off.

I'm sorry for those people who were tricked into buying homes with unaffordable loans. I'm sorry for those who "did everything right" and ended up holding an upside-down mortgage. I'm sorry that they don't have enough room for growing families and that they can't upgrade. I'm sorry their contract with the American Dream has been violated.

But let me tell you a story.

In 1989 my spouse and I purchased a decrepit & abused property home that took every last nickel out of our pockets. (I personally stuck my nose into 50 homes to find one that we could actually theoretically afford.) The mortgage payments were $1824/month. By 1990 we'd put enough sweat equity into the property to add 50% to its value, although a rising real estate market certainly helped with about half of that. By 1991, after DESERT STORM, the Japanese equity bubble popped and (most) Japanese citizens stopped buying Hawaii real estate. The Hawaii real estate bubble also popped, and nearly as big as today's Las Vegas or Florida. By 1999 our home's value had been cut by 45% off the peak-- and 15% less than what we'd paid for it.

In 1992 (while our property value was starting down from the top of the roller-coaster ride), we'd both been promoted (higher salaries) and back then the govt rules for military housing allowances effectively said "spend it or lose it". In order to spend our govt subsidy, we refi'd that 30-year mortgage to a 10-year mortgage with a fixed $2631.97/month payment. It'll be clear in a bit why I remember that number so well.

In 1994 the military wouldn't let us stay in Hawaii. During the biggest drawdown since WWII, there were no billets for our current ranks & specialties. We moved to San Diego, which had a much lower housing allowance, yet we spent all of that housing allowance to afford the rent on a SD home that was nowhere near the quality of our Hawaii home. We spent the next three years trading our home-improvement sweat equity on that property in exchange for no rent increases (which we couldn't afford). We saved the landlord thousands of dollars in repairs and raised its value by at least another $25K. This was in addition to our full-time Navy jobs and raising a toddler but, hey, we enjoy home improvement.

Meanwhile we were still paying the mortgage on that Hawaii property while grossing $1600/month in rent, minus all the usual landlord expenses. You can do the math on that one.

Military homeowners could tap into a number of programs like the "Homeowners Assistance Program" available to help out owners of distressed real estate. (The values of Makaha homes were cut almost two-thirds by the closure of a nearby military base). We could have negotiated with the lender. We could have obtained all sorts of forgiveness and help.

Instead we chose to suck it up and pay the damn mortgage. In fact we actually paid it off in the late 1990s, about the same time that our home's value hit rock bottom.

Did it hurt? You bet. We had to change our lifestyle, our budget, our spending, and just about everything. Having to stare that payment in the face for 39 consecutive months made a powerful difference in our behavior.

You know what? We learned to dramatically cut our expenses and to reduce our "needs" to our essentials while practically eliminating our "wants". We knew that we'd never again overextend ourselves to such a risk. That mortgage payment didn't put us on the path to ER, but it certainly showed us how to become financially independent.

I think lenders and homeowners should be allowed to do the math to decide whether it's worth refinancing an underwater home. In most cases it's a good idea. In fact, I bet that it's a good enough idea that there's no need to let the lobbyists persuade us to award amnesty to the criminals who helped cause this problem in the first place. This is one situation where I believe a small rule change or two could help facilitate an economically sensible transaction, but there's no reason to go overboard to the point where we're subsidizing it with our tax dollars.

[chinaco]

It sounds like they are just rolling back the rules to pre-meltdown bubble days... the situation that got us here to begin with. Loan more than its worth, no underwriting, no appraisal, etc.

The only words that come to mind to me: Transfer of wealth from savers (401ks, IRAs, etc) to mortgage holders (because of the Feds actions).

Plus, few economist seem to think it will fix the housing problems at a macro level because Fannie and Freddie only hold 1 in 7 of those loans. The others are held by banks directly and they do not intend to play.

[MichaelB]

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Originally Posted by samclem The NYT has a short piece about the new program: In part: So, the new program will let the originators off the hook for any malfeasance (charitably called "problems" above--cute) regarding the original loan. One means of "holding Wall Street accountable" are the potential civil and criminal penalties for firms that deliberately broke the law in writing bad loans (liar loans, fraudulent appraisals, etc). This new proposal closes a door by which taxpayers might recoup some of our growing losses. Another gift, from our kids.

This is what the NYT piece says

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Fannie Mae and Freddie Mac generally require refinancing lenders to assume responsibility for any problems with the original loan because in making the new loan they are relying in part on that original documentation. That has made lenders reluctant to refinance loans for which they are not already responsible. That provision will now be waived, in exchange for a fee.

Originators of bad loans are not getting any break. They are still liable and can be prosecuted. All that is happening is the liability is no longer being transferred to a new lender. A report in the FT confirms this

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Most important to lenders, the FHFA will no longer hold originators of the new mortgage responsible for underwriting errors and other irregularities committed by the original mortgage lender.

[MichaelB]

Repayment risk for MBS investors is real, but that certainly is not unique to this rule change, nor is it new. In fact, most mortgage holders have had many opportunities to refinance. Why should this be different? That is, why is it a problem if the mortgage is >125% of home value but not a problem when home value is <75%?

[ERD50]

The snippet that clifp posted is just plain crazy:

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Another unsettling wrinkle: The FHFA is adding an incentive for borrowers to refinance into shorter-maturity mortgages. But in many cases, this will mean a borrower's monthly payment, including principal repayment, won't decline. It may actually rise. That undermines the notion that these borrowers are unable to meet monthly payments and need government assistance.

This defeats the whole purpose (well, any positive purpose that I can see). That won't stimulate the economy.

Being only applicable to Fannie/Freddie is a kind of selectivity that I don't like either. So your neighbor gets this deal and you don't?

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Originally Posted by MichaelB Repayment risk for MBS investors is real, but that certainly is not unique to this rule change, nor is it new. In fact, most mortgage holders have had many opportunities to refinance. Why should this be different? That is, why is it a problem if the mortgage is >125% of home value but not a problem when home value is <75%?

It's different because the govt is looking to change the rules mid-stream. The 'problem' is simple mathematics. If the new rules encourage more refinancing than before, there will be a faster drop in yields.

I recall some recent threads where some people were insistent that the deal offered at one point in time must be offered unchanged for their life-time, and changes were spoken of in derogatory terms. This is worse, they are not looking to freeze the current GNMA conditions, and only apply this to people who purchase GNMA funds going forward. That would be closer to fair. This will affect past purchases made under a different set of rules.

-ERD50

[clifp]

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Originally Posted by MichaelB Repayment risk for MBS investors is real, but that certainly is not unique to this rule change, nor is it new. In fact, most mortgage holders have had many opportunities to refinance. Why should this be different? That is, why is it a problem if the mortgage is >125% of home value but not a problem when home value is <75%?

You are right repayment are one of the risk of purchasing MBS or GNMA funds. However the difference is that government hasn't in the past tilted the rules to so dramatically to encouraging refinancing and thus transfer billions of dollars of income from MBS investors like us, to borrowers in the form of lower payment.

When I (or actually the managers at Vanguard, Fidelity etc.) purchase a MBS security issued by Fannie, Freddie, or Gennie, there are only a few factors to consider, the coupon rate, the weighted maturity, and the credit quality of the mortgages (FICO scores of borrowers, LTV of the mortgages). One of the features of GNMA is that they are geographically diverse, but credit and interest rates homogeneous.

This means that Nord's mortgage with his good credit score, might have been packaged with my mortgage in Silicon Valley, along with mortgages of folks with good credit from Ohio, Texas, Florida, Detroitetc. Now up until 2008, in any given year some real estate markets in the country were booming and other were flat or down. This means that if interest rates dropped I as an MBS owner in the 90s would expect to see a increase in refinances in place like Silicon Valley or Florida where real estate prices were increasing, but in places like Hawaii, or the rust belt, it would be difficult for people to refinance for the reason Nords outlined.

A related issues is how will the Fannie/Freddie package these new, negative equity loans. In the past one of the reasons that mortgage rates were so low is that were backed both by properties and the borrowers willingness and capacity to pay. These new refinance loans only are backed by the borrower. Sure they guys may have been paying faithfully, but if they get laid off, hit by a bus. How will the investor have any idea how much the underlying a collateral is worth. Imagine two $200K mortgages from 2007, they may both be underwater but as investor I sure want to have the mortgage written in Virginia a lot more than the one in Vegas.

Of course it seems that Mr. Market has already made up its mind, and us savers are screwed again.

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Prices for billions of dollars in mortgage bonds fell to their lowest levels in six months on Monday as traders bet that new measures to help distressed homeowners would lead to a wave of early repayments.

[samclem]

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Originally Posted by MichaelB This is what the NYT piece says . . .

Thanks. Yes, that's what the NYT article says now, but they extensively reworded the article since I posted.

It would seem proper for news publications to note errors/corrections when they change a posted article, just as they do with print versions.

[MichaelB]

I really don’t get the declining yields / MBS issue. Refinancing has been going on steadily for the past 10 years as mortgage rates decline. Tens of millions of homeowners have refinanced multiple times over this period, taking $T’s from home equity over the past decade. Now we complain because a group that probably represents less than 1% of homes and 2% of mortgages will have an opportunity to refinance (and hopefully reduce risk of foreclosure)?

If refinancing is an issue for investors, it is not new and has little to do with this rule change.

[Texas Proud]

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Originally Posted by MissMolly They would be new loans. A lender cannot substitute a lower interest rate loan for an existing loan in a pool. The loan would have to be bought out of the pool (paid off) and then the new loan made and re-pooled.

The CMOs that I dealt with did have language in them that allowed 'workouts', so it is not quite clear if it is bought out or not.... I would assume that it would be a new loan, but neither you or I know for sure...

And as I mentioned, what language are you putting in the new pool if they are new loans 'We have X% of loans that are underwater in the portfolio, so good luck with getting your money back'.... or will the gvmt just hold them and not package them at all... and from what I saw last night on the news, ONLY underwater loans qualify, so that would be 100% of underwater loans if they all went in the same pool...


Edit to add:

If this is true, then the loans are new...

"Missing from that winners' list: investors who finance housing markets by purchasing mortgage-backed bonds. They will fund this new effort. Here is how: As homeowners refinance, investors who bought mortgage bonds will be given back their money and will have little option but to reinvest at far lower yields. The transfer is the difference in yield..."

[ERD50]

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Originally Posted by MichaelB I really don’t get the declining yields / MBS issue. Refinancing has been going on steadily for the past 10 years as mortgage rates decline. Tens of millions of homeowners have refinanced multiple times over this period, taking $T’s from home equity over the past decade.

What's not to get? Refinancing affects GNMA funds, that's a given. Anything that increases that rate of refinancing affects it even more.

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Now we complain because a group that probably represents less than 1% of homes and 2% of mortgages will have an opportunity to refinance (and hopefully reduce risk of foreclosure)? If refinancing is an issue for investors, it is not new and has little to do with this rule change.

Complain? It is a factor in this discussion. There are positives and negatives to this proposal. We are discussing them.

I get the impression that since you think this is a good idea, that you simply don't want to hear any discussion of any negative affects, they are just dismissed as 'complaints' or 'political'?

I do not have any idea of the extent that this will affect yields/NAV of GNMA funds. But it is worth discussing. Just like you thought this info would be of value to people looking to re-finance, I think the GNMA issue is of value to the many GNMA investors on this forum. I hope we can have an objective discussion of all sides of this issue, else, what's the point?

-ERD50

[Texas Proud]

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Originally Posted by MichaelB I really don’t get the declining yields / MBS issue. Refinancing has been going on steadily for the past 10 years as mortgage rates decline. Tens of millions of homeowners have refinanced multiple times over this period, taking $T’s from home equity over the past decade. Now we complain because a group that probably represents less than 1% of homes and 2% of mortgages will have an opportunity to refinance (and hopefully reduce risk of foreclosure)? If refinancing is an issue for investors, it is not new and has little to do with this rule change.

I agree with this... according to the numbers on the news last night, this will only affect 400K ish from one estimate up to 2 mill from another...

Yet, we have 6 million people either being forclosed on or about to be foreclosed...

And to an investor of bonds.... would you not want to get rid of a possible walk away or foreclosure All these loans have a higher probablility of a foreclosure... I would rather get rid of them from my portfolio.... now, being in a GNMA fund does not accomplish that, but the change is probably not even 1 BP... let alone 10....

[youbet]

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Originally Posted by ERD50 It's different because the govt is looking to change the rules mid-stream.

But doesn't the real new rule state that it's now OK to change the rules mid-stream? Thinking back to the GM bailout, it seems like today investment decisions are guided not only by the rules in effect when you made the investment but also by your guesstimate of what the gov't will do to change the rules going forward.

I own a slug of GNMA in deferred accounts. Years ago when I made the decision to purchase them, I should have not only considered the rules in effect at that time but also that these changes might happen now. What was I thinking?

It continues to amaze me that I'm not housing the family under an Interstate bridge and feeding them out of dumpsters......... yet.

[clifp]

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Originally Posted by MichaelB I really don’t get the declining yields / MBS issue. Refinancing has been going on steadily for the past 10 years as mortgage rates decline. Tens of millions of homeowners have refinanced multiple times over this period, taking $T’s from home equity over the past decade. Now we complain because a group that probably represents less than 1% of homes and 2% of mortgages will have an opportunity to refinance (and hopefully reduce risk of foreclosure)? If refinancing is an issue for investors, it is not new and has little to do with this rule change.

I think you are missing the point why should this group have additional income at the expense of my Mom and all the other purchaser of MBS?

Assuming you are right and it is 2% of the mortgages which will be replaced with much lower interest. This represents several hundred dollars a year to my mom in lower GNMA interest, more than negating her SS increase next year. She has already suffered roughly a $500/month loss income due to drop in mortgage interest rates. Now this part of the risk she took with investing in these securities, if interest rates drop she was going to lose income.

The people who purchased this homes knew at the time what their house payments would be. They had the option at the time of getting an adjustable rate, which would have lowered their payments when they adjust in the next year or so. Presumably if they had suffer job loss, medical crisis etc., since they badly underwater, they would have defaulted by now. So this is strictly an income transfer from one group to another.

Yes they would have been better off with a adjustable mortgage, and certainly better off renting. Just like Mom would have been better off moving all the GNMA money into 6% PenFed CDs in 2007.

Nord's story points out something pretty important, these folks maybe underwater now, but I guarantee if they keep paying their mortgage for the next 27 or so years they will be above water. (if not much sooner).

Lets imagine that house prices continued to go up and interest rate rose in 2007-2011. Mom's GNMA fund would have dropped in value, and while her income would increased it would have lagged the rising interest rates. Do you think there would be government program that would require people with fixed mortgages to refinance, to bail out all of the investors stuck with low interest fixed mortgages and declining GNMA fund values. Some how I doubt it.

[ERD50]

Quote:

Originally Posted by youbet But doesn't the real new rule state that it's now OK to change the rules mid-stream? Thinking back to the GM bailout, it seems like today investment decisions are guided not only by the rules in effect when you made the investment but also by your guesstimate of what the gov't will do to change the rules going forward.

You are correct, we are seeing a trend here. I'm starting to worry that if I invest in company XYZ, the govt will announce that they are subsidizing their competitor, and wipe out my investment (which affects my FIRE status, if that isn't clear).

This has to have some effect on investors, and to whatever extent we reduce the motivation to invest, we are hurting our economy.

So there are two questions to this proposal:

1) will this plan (since it only affects a small number of mortgages) really have a positive affect on the economy?

2) Is it 'fair' to make a deal for one group that hurts another group, if even by a small amount (since it only affects a small number of mortgages)?

-ERD50

[MichaelB]

Quote:

Originally Posted by ERD50 I get the impression that since you think this is a good idea, that you simply don't want to hear any discussion of any negative affects, they are just dismissed as 'complaints' or 'political'? -ERD50

By correcting a misleading new report or challenging the contention that refinancing is an issue?