How to help underwater homeowners

Tue Nov 9, 2010 1:00pm EST

An estimated 11 million homeowners - perhaps 25 percent of all homeowners - are "underwater", a situation where their mortgage exceeds the present value of their home. Many are making their payments faithfully each month, and virtually all would benefit from a chance to refinance. Since they are "underwater", they cannot.

The majority of these homeowners have done nothing wrong, save for purchasing a home at the wrong time, at or near the peak of the market. Be it bad luck or bad timing, they are trapped in the mortgages they chose. In this poor economic climate, and with increases in incomes weak, the best and perhaps only way to substantially improve a household balance sheet is through refinancing.

Underwater homeowners have watched as various initiatives and programs have been rolled out to support failing homeowners. Of course, these programs are only available to those who have already failed (or are in danger of failing) to meet their obligations. Some offer interest rates as low as 2 percent for up to five years and also pay down mortgage balances by up to $1000 per year over that time. Under existing programs, a homeowner can realize great benefit if they fail to live up to their obligations, and to date, most of them have been expensive and ineffective in stabilizing the housing market.

However, current-but-underwater homeowners can find no relief. They cannot access today's record-low interest rates to help ease their burden, and all the while are being asked to pick up the tab for any number of housing supports and bailouts for others. Our good-but-trapped homeowners get nothing but the bill. We propose a program for underwater homeowners who make their payments on time and expect to continue to do so — a reward for doing the right thing.

There have been half-hearted attempts to help these underwater folks. These's the HARP program, but you loan has to be held entirely by Fannie Mae or Freddie Mac and you must find a lender who will work you into the program. There's also the new FHA Short Refi, a voluntary program that requires the loan's owner to forgive at least 10 percent of the loan's principal; this creates a substantial loss for someone who also did nothing wrong except lend money to someone who wanted to buy a home. Finally, there have been calls to have Fannie and Freddie simply write new mortgages for these homeowners, but this instantly transmits billions more in losses to the GSEs, and ultimately to the taxpayer.

Instead of these, HSH.com's idea is to involve the federal government as a guarantor of the difference between the amount of the existing mortgage and the present value of the home, in a program we call the ValueGap Refinance. Once this differential is established through an appraisal process, the homeowner would obtain a new loan at 100 percent of the property's current value and at today's market interest rates.

Our plan would have the homeowner pay interest on the difference between the current value and the old loan balance — the actual value gap — at today's interest rates. However, we would not make the homeowner responsible for paying off the principal of this gap; rather, when the home is sold to a new buyer at some point in the future, the government would pay the difference between the final selling price and the original loan balance to the investor. As such, the government would pay out no money today, and the investor would not need to take an immediate loss. This would provide the investor a strong incentive to participate in the program.

Homeowners who participate are those who are likely to want to stay put. As home prices slowly recover or even rise over time, that value gap — and the government's potential obligation — would be diminished, possibly even to zero cost when the home is sold. We also allow for a fee-based loan structure to help reduce the government's cost more quickly.

There's no instant equity "reward", either. The homeowner would realize no equity stake unless the final sales price exceeded the original loan amount and the government's obligation was covered in full.

While not a simple plan, the homeowner gets a benefit, the investor isn't penalized, and the government's costs would be both known and should diminish over time. Billions of dollars now committed to high-rate mortgage payments would be available to be spent, boosting the economy and stabilizing both household balance sheets and neighborhoods. We think that it is a plan whose time has come.

-- Keith Gumbinger is vice president of HSH.com, which publishes mortgage and consumer loan information. The views expressed are his own.---