The FHA Refinancing Option for Troubled Loans—Doing it Right

Now that the American Housing Rescue and Foreclosure Prevention Act has been signed by the president, let us examine one of its key provisions. Under this act, the Federal Housing Administration is allowed to insure up to $300 billion in new mortgages for at-risk borrowers living in owner-occupied homes, provided the lenders agree to write down the loan balances to up to 90 percent of the homes’ current value.

This new legislation and the congressional bills that preceded it have been called many names, including the Bank of America bill on steroids and the Bank of America Relief Act.

This last phrase came recently from Jim Cramer, a prominent investment adviser and television personality. Cramer points out that Bank of America wrote the Countrywide mortgages down to 30 percent and can now write them back up by flipping them to the FHA for 80 percent.

A question we should be asking when a private bank can negotiate with a subprime lender and get it to write down mortgages to 30 percent, is why can’t the government (FHA) do the same for the loans of various subprime lenders that it will now acquire under the American Housing Rescue and Foreclosure Prevention Act?

One obvious answer is: “Because it is the government — duh!”

We Americans should not accept such an answer. We should demand the highest standards of efficiency and financial prudence from our government. The FHA must take the utmost care to avoid waste in the use of public monies.

In the spirit of competition, let private banks negotiate with subprime lenders to get the troubled home mortgage loans to be written down to the lowest value — the deepest discount, and then let the FHA acquire these from private banks, allowing them a reasonable margin of profit (not a spread of 50 percent, but say about 10 percent). The FHA should give a priority to picking up the loans written down by the largest proportion. This will be an incentive for banks to negotiate the lowest write-downs. Banks will then compete with each other to negotiate for the deepest discount. This is beneficial to the homeowner as well as to the taxpayers. The homeowner will have a smaller outstanding mortgage loan and taxpayers will be responsible for a much lower amount.

How the FHA will implement this program will do a lot to prove or disprove whether this is indeed a “Bank of America Relief Act,” and will reveal the emphasis the FHA places on obtaining the best value for the government (and taxpayer).

Under the American Housing Rescue and Foreclosure Prevention Act, for any FHA refinancing to occur, lenders will have to agree to write down loan balances to up to 90 percent of the homes’ current appraised value. Homeowner advocacy groups will have to be alert about how “current appraised value” of the home will be estimated by the FHA. There is certainly an incentive on the part of lenders to overvalue this. It is ironic that over-appraisals of home values was a chief source of the current housing crisis, and it could again plague the “rescue” plan. Indeed, fraudulent and systematic over-appraisals has been a leading predatory lending practice. Homeowner advocacy groups will now have to be alert to this aspect of the FHA plan.

It is worth noting that Bank of America has made handsome donations to some of these organizations, and other lenders are also assiduously cultivating some of these groups. Big corporation money is hard to ignore.

We need to develop some criteria by which we can assess the success of the FHA plan. These might include:

  1. How many at-risk homeowners obtained the FHA refinancing, and by how much was their mortgage payment reduced as a result of it?
  1. How many of the homeowners who obtained the FHA refinancing were able to sustain their homeownership over time?
  1. Were minority homeowners and lower-income homeowners assisted under this program in adequate numbers?
  1. Has the program resulted in higher minority homeownership rates?

The FHA program is scheduled to begin on Oct. 1, 2008. This month (August) is the time to thrash out these relevant issues so that the homeowner rescue plan will get done right.

Nandinee Kutty
Dr. Nandinee K. Kutty is an economist and a policy consultant. She is an editor and contributor for the book Segregation: The Rising Costs for America (Routledge 2008). She is the author of numerous research papers published in peer-reviewed journals of economics and public policy. Dr. Kutty was formerly a professor at Cornell University. Her published research papers and op-eds are currently on the reading lists for courses taught at various universities in the U.S. Her e-mail address is nndkutty@aol.com.

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