Refinancing lifeline fails to reach most 'underwater' homeowners
Federal plan misses about 97 percent of eligible borrowers

By Renae Merle
Saturday, October 24, 2009

A seven-month-old government program to help homeowners with little or no equity refinance their mortgages has so far reached fewer than 3 percent of those targeted, with many struggling borrowers deciding that the benefits of a new loan aren't worth the closing costs.

This lackluster performance reflects the difficulty of helping the growing segment of "underwater" homeowners -- those who owe more than their home is worth.

The program is a key component of the Obama administration's efforts to stabilize the housing market and arrest the nation's growing foreclosure rate. But the initiative has received far less public attention than its companion, a loan modification program that pays lenders to lower the payments of delinquent borrowers who are in imminent danger of losing their homes.

The refinancing program targets borrowers who are not in trouble on their mortgage now but, because they are underwater, are at risk of falling into trouble later. By suspending the traditional refinancing requirement that borrowers have equity, officials hope to make them less vulnerable to foreclosure. Homeowners whose loans are backed by mortgage financiers Fannie Mae or Freddie Mac are eligible.

This effort has so far helped about 130,000 of the up to 5 million borrowers the Obama administration has said are potentially eligible, according to government data.

"We would have liked to move at a faster pace, but it does take time to ramp up," said Seth Wheeler, counselor to the secretary at the Treasury Department. But "it has been a substantial help to those that have been able to refinance."

Ironically, the program is struggling during one of the nation's largest refinancing booms. Mortgage rates have hovered at 5 percent or below for 30-year fixed rates in recent weeks, according to a weekly survey from Freddie Mac. The value of refinanced loans is on track to jump 60 percent this year, according to the Mortgage Bankers Association.

During a recent conference call with reporters, Treasury Secretary Timothy F. Geithner noted that, with mortgage rates near historic lows, 3 million homeowners had already refinanced this year. That refinancing boom pumped $10 billion in purchasing power into the economy, chimed in Shaun Donovan, secretary of the Department of Housing and Urban Development.

But those benefits have yet to trickle down.

"The government is spending a trillion dollars to drive mortgage rates down, and it's been successful. But who is taking advantage of that? The people with the best credit and best equity. Not the people on the fringes," said Bob Walters, chief economist of online mortgage company Quicken Loans.

Scarce equity

Recent studies have shown that one-third of borrowers are underwater on their mortgage. In the Washington region, about 34 percent of borrowers owed more money than their homes were worth during the first quarter of the year, according to First American CoreLogic. The problem is most acute for borrowers who took out loans in 2006 and 2007 -- about 60 percent of them are underwater, according to Fitch Ratings.

Yet for many underwater borrowers, refinancing isn't always attractive because they could still owe more than the value of their home and face years of payments before they regain equity. Refinancing can be especially risky for those homeowners who might move within a few years or who are nervous about losing a job.

"If you're deeply underwater, it's going to be a long time before you regain equity, unless housing seriously rebounds. So investing more in the house is maybe not the best strategy," said Andrew F. Haughwout, a research economist at the Federal Reserve Bank of New York.

At the same time, government and industry officials say that many borrowers can't even afford the help. Under the program, borrowers must still pay traditional closing costs, which can run thousands of dollars. And those with little equity in their homes are charged higher fees under the program's rules because they are considered a higher risk.

"You have a borrower who says, 'I am so underwater and you want me to pay more to stay put -- maybe not,' " said Andrew Jakabovics, associate director for housing and economics and the Center for American Progress.

Moreover, many borrowers are so far in the hole they couldn't qualify for the federal program even if they wanted to.

Shelley Danzer hoped to refinance the mortgage for the home she purchased in 2005 outside Phoenix for $163,000. She had initially put down almost $35,000. But local real estate agents told her not to bother with the $400 appraisal fee. Homes in her neighborhood are now selling for about $60,000, putting her too far underwater to qualify for the program.

"I love my house. It's not that I want to give it up, but if I needed for some reason to leave I would be pretty [out of luck] right now," said Danzer, who estimates she could save $200 to $250 a month by refinancing. "I would have to just let it go."

Series of hurdles

The government refinancing program was initially hamstrung as banks and other lenders undertook the time-consuming process of updating their computer systems to process the loans, industry and government officials say. Many applicants had more than one mortgage or they had mortgage insurance, both of which made refinancing more complicated. There was also initial confusion as borrowers tried to determine whether their loans were backed by Fannie Mae or Freddie Mac and thus eligible for the program.

The deteriorating housing market also tripped up the program. It was initially limited to borrowers who owed no more than 5 percent more than their home was worth. But it quickly became apparent to administration officials that home prices had fallen so much that many borrowers fell outside those parameters.

In July, the Treasury Department raised the limit to include borrowers who owed up to 25 percent more than their home is worth. The higher limits went into effect for borrowers with Fannie Mae-backed loans in September and for Freddie Mac borrowers this month. Treasury officials expect the program to pick up momentum now that the higher limits have been put in place.

Though the housing market has stabilized in some parts of the country, home prices are expected to fall nationally through next year as foreclosed properties continue to pile onto the market, economists said. On average, home prices are likely to fall another 7 percent by early 2011, bringing them down 28 percent from their peak in 2007, according to IHS Global Insight. The numbers are even more dramatic in hard hit parts of the country, such as Arizona and Florida.

During previous housing downturns, negative equity was less of a concern. But this time, a greater proportion of borrowers bought at the peak of the market with little or no down payment, housing experts say.

With negative equity, these owners can't tap their house for cash if they face a personal crisis, such as a job loss or medical emergency, putting them at a higher risk of foreclosure. By contrast, borrowers with positive equity have more options, including selling their home to avoid foreclosure.

Leaving homes behind

A growing number of underwater borrowers are walking away from their homes even if they can afford the payments, according to recent studies. More than 25 percent of mortgage defaults during this housing crisis have been so-called strategic defaults, according to a study published in June by professors at Northwestern University, the University of Chicago and the European University Institute. Another study by credit bureau Experian and Oliver Wyman, a strategic consulting firm, estimated that nearly 600,000 borrowers "strategically defaulted" on their mortgages in 2008, more than double the number from 2007.

Housing experts say these borrowers are calculating that their homes are no longer a sound investment. For example, a borrower who is 25 percent underwater would spend nearly 10 years making regular payments before regaining any equity in the home, according to mortgage research firm HSH Associates.

"They are effectively renters with all of the costs of homeownership," said Jakabovics at the Center for American Progress.

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