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The Price of Foreclosure Prevention

May 5, 2008 - by Donny Shaw

Nobody knows if taxpayers will have to front for a foreclosure prevention plan that’s going to be debated in the House this week. The bill, which would help about half a million at-risk homeowners avoid foreclosures by allowing the FHA to refinance new mortgages, could come at a cost to taxpayers, it could pay for itself, or it could make money for the government.

The proposal would only come at a cost to the government if homeowners defaulted on the new FHA loans. But since the new FHA loans would require homeowners to share any appreciation in the value with the government, there is a mechanism in place for making any money lost in defaults back.

Last Friday, the Congressional Budget Office released a report estimating that the total cost of the bill at $2.7 billion. Here’s the Heritage Foundation’s take:

>According to the CBO, about 2.8 million homeowners with exotic mortgages will face foreclosure over the next four years. 40% of that 2.8 million have second liens on their homes rendering them ineligible for the program and less than 40% of the remaining group will find their primary lenders willing to participate. An earlier CBO study of the Dodd plan concluded “the plan would not be sweeping enough to restore the housing market or ailing economy.”
>So how much will American taxpayers pay for a plan that helps nobody and does nothing to help the economy? The CBO’s Friday study also estimated that if just one-third of the problem mortgages FHA insures fails, taxpayers will be on the hook for “only” $2.7 billion. So the plan now being pushed by Frank would do nothing to help most homeowners at risk, would do nothing to hep the economy, and would cost American taxpayers $2.7 billion.

The CBO estimate, based on one-third of the new FHA mortgages eventually failing, is still wildly speculative. Here are some of the eligibility requirements the bill would implement to help ensure the new mortgages don’t fail (from this House Financial Service press release):

  • New FHA loans must be properly underwritten and must be based on current appraised value of the house and borrower’s documented income (borrowers with higher – but not disqualifying – debt levels would need to make six months of timely payments at the new payment level to qualify for the guarantee);
  • New FHA loan must extinguish all existing liens and substantially reduce the borrower’s mortgage debt service;
  • New FHA loans under this program must be within the FHA loan limits now in effect under the stimulus for the duration of this program;
  • Oversight Board will set reasonable limits on loan fees and interest rates; and
  • To reduce costs to the government – and avoid inappropriate enrichment to the borrower – the government will retain a share of the borrower’s future profits. When the borrower sells the home or refinances the loan, the borrower will pay from any profits the higher of (1) an ongoing exit fee equal to 3 percent of the original FHA loan balance; or (2) a declining percentage of any net proceeds attributable to home appreciation (i.e., from 100 percent in year one to 50 percent in year four and thereafter minus the fees the borrower has paid into FHA).

There are a lot of details to be worked out here. The success of the new mortgages relies heavily on how current home values are appraised and how incomes are verified, also on how terms like “substantially reduce” and “reasonable limits” are defined in the details that will have to be worked out by HUD if this is implemented.

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