Wednesday, May 21, 2008

Senate version of the FHA "bailout" bill anything but a bailout.

The "Federal Housing Finance Regulatory Reform Act of 2008" was passed by the Senate banking committee today. I'll review a few technical details and explain why I think this bill, if passed with the revisions added today, will be a significant win for those wanting a market driven solution to the housing crisis over those wishing government intervention.

The basic idea is that the FHA will insure a mortgage if the lenders will take a voluntary cut to principal and the borrower will be able to pay the newly written down mortgage. People characterized this as a bailout of lenders because the amount they would get on a refinance would be more than the amount they could sell the mortgage for on the open market. Borrowers get the benefit of taking on a mortgage they couldn't afford with little to no down payment, thus fueling the housing boom, and getting a significant amount of money written off so they can stay in the home.

Let's take a hypothetical $600,000 mortgage taken by a couple making $80,000 a year. Under the plan the lender must write down the mortgage to 90% of current appraised value. If we say the house currently appraises for $500,000 dollars then the borrower is qualified and paying off a $450,000 remaining balance. The lender will also pay a one time premium payment of 3% of the insured amount to FHA plus, presumably, other fees and origination costs on the loan because the borrower would have no money. So the lender at the end of the gets around 85% of current appraised value for a house. Considering foreclosure, carrying and selling costs, not a bad deal in the current marketplace.

Now onto the borrower, he gets all junior mortgage lines forgiven and any prepayment penalties and late fees waived. The borrower cannot own another home, cannot be defaulting on his house intentionally (could luck enforcing that), must be living in the home and have verified income. The exact wording for verified income was :

INCOME.—In complying with the FHA underwriting
requirements under the HOPE for Homeowners pro
gram under this section, the mortgagee under the
mortgage shall document and verify the income of
the mortgagor by procuring an Internal Revenue
Service transcript of the income tax returns of the
mortgagor for the 2 most recent years for which the
filing deadline for such years has passed and by any
other method, in accordance with procedures and
standards that the Board or the Secretary shall establish.

The remaining mortgage must be "affordable" to the borrower. And while no rule is given in this section as to affordability they do talk about affordability in two places. For FHA secure a loan can be refinanced to 35% debt-to-income (DTI) and for this program only loans above 31% original DTI qualify to be refinanced. So the DTI number is either 31% or 35%.

If we look at a $450,000 loan with a 30 year fixed at 6% we get the following numbers:
  • $2,697.98 for a fully amortized payment.
  • $468.75 in property taxes (California ~1.25% of purchase price, we will adjust it down to reflect the declining market)
  • Homeowners insurance @ $75 a month

This initial total is $3,241, then we have to add in the FHA mortgage insurance premium. For this program it is a 1.5% of the original mortgage balance a year for 5 years. This adds another $625 a month to the payment. Under a 31% max DTI the borrowers income must be $149,679. Under a 35% max DTI the borrowers income must be $132,573. These debt to income restrictions combined with high mortgage insurance premiums ensures that anyone entering the program will either have a significantly lowered mortgage or just be on the edge of affordability and get a hand up into keeping the home.

If you consider other portions of the bill, particularly the GSE regulator, I think the bill would not be a bailout for anyone and could in fact help ensure a safer more sound marketplace sooner rather than later. Frank & Dodd may let the bill pass in its current toothless form in the hopes of changing it after next January.

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