Fannie Mae and Freddie Mac released the expected modifications for the Home Affordable Refinance Program (HARP 2.0) on Tuesday. As promised, the Federal Housing Finance Agency (FHFA), the conservator agency formed to oversee the activities of the GSAs-- Fannie and Freddie, expanded the program. The three key changes relate to the following items:
- Elimination of the 125 percent loan-to-value (LTV) ratio
- Reduction of the loan level pricing adjustments
- Waivers for representation and warranties
Under the old program, the 125 percent LTV cap excluded many homeowners from refinancing. Removing this ceiling allows borrowers who have underwater mortgages because of declining property values to refinance to new loans with lower interest rates. However, some LTV requirements remain in place for certain types of mortgages.
LTV and Hybrid Mortgages
FHFA decided to keep the 105% maximum LTV for adjustable rate mortgages. This aspect of mortgage financing applies more to real estate investment trusts (REITs) that invest in Fannie and Freddie mortgage-backed securities consisting of “hybrid” adjustable-rate mortgages.
The Federal Reserve Board describe Hybrid ARMs as mortgage products marketed by lenders as 3/1, 5/1, 7/1 or 10/1 adjustable rate mortgages” Hybrid ARMs have a combination of a fixed-rate period and an ARM period. For the first two or three years, the borrower has a fixed interest rate.
For example, a 3/1 ARM has a fixed interest rate for three years. After the initial period, the interest rate may adjust every year – signified by the “1” in the 3/1 example.
LLPA Reductions Lower Refinance Costs
Another revision made under HARP 2.0 involves Loan-level Pricing Adjustments (LLPA).
Loan-level Pricing Adjustments refer to modifications in the cost of a mortgage, which lenders base on individual risk factors, such as a low credit score, high loan-to-value ratio (LTV) or property type.
The typical American borrower has never heard of LLPAs. It has been in use since 2008--in an attempt to keep Fannie Mae and Freddie Mac from going under.
It works like this:
Think about seeing an advertisement for a low interest rate loan, but when you submit your mortgage application to the lender, you receive a quote one half-point higher than the “advertised interest rates.” Most people may think the lender is pulling a “bait-and-switch” tactic. More likely, the reason for the higher interest rate has to do with Loan-Level Pricing Adjustments.
Advertised rates usually go to borrowers with FICO scores in the top range—somewhere around 750 to 850. Lenders can always raise the range, as some borrowers have experienced.
LLPA goes down to zero for fixed-rate mortgages with durations less than or equal to 20 years. Adjustable rate and fixed-rate mortgages that exceed 20 years will have an LLPA of 75 basis points (bps). Borrowers with 30-year, fixed rate mortgages, who refinance into the same mortgage, will have a 75 basis point reduction. This equals a decline of 15 basis points each year.
Basis points equal 1/100th of one percent. The financial industry uses BPS to calculate changes in interest rates and other financial instruments.
Market analysts from Amherst Securities Group state borrowers who refinance through Fannie and Freddie, and have LTVs lower than 80 percent, will likely have more frictions than those with higher ratios –especially with Freddie Mae. Analysts expect borrowers to incur higher LLPAs for non-HARP refinancing under Fannie Mae. Freddie Non-HARP refinances may require borrowers to pay higher LLPAs. However, lenders continue to have liability for representations and warrants made under the original mortgages.
Changes in Representations and Warrants Liabilities
HARP 2.0 protects lenders from specific representations and warrants—for Freddie borrowers with loan-to value ratios above 80 percent—as long as the new loan has the same servicer. As it relates to Fannie Mae, mortgage lenders have more waivers, which only apply to loan originators who employ Desktop Underwriter (DU) Refi Plus.
Introduced in May 2009, DU allowed borrowers to refinance a maximum of 105 percent of the value of their own. The program reduced documentation requirements and accepted borrowers with credit scores below Fannie’s 580 requirement.
Conclusion
The housing and mortgage industries have awaited the details of HARP 2.0 since the Obama Administration made it their focus in late October. The FHFA agreed to loosen the stringent requirements, which shut many borrowers out of taking advantage of historic low interest rates for mortgages.
The original program fell short of it target goal of helping up to four million struggling homeowners obtain some degree of relief—with only 894,000 able to avail themselves of the program. Last month, the FHFA said it may double the number of borrowers eventually refinanced under the original HARP.
FHFA extended the refinancing deadline to the end of 2013.