Will This Week’s Mortgage Relief Help Underwater Home Owners?

The WSJ reports that the Obama administration will roll out an expanded program this week to help home owners whose home values are less than their mortgages (excerpts below). Banks that reduce loan balances will have more flexibility in refinancing existing loans into new FHA-insured loans. Hats off to the administration for trying to help, but FHA loans come with mortgage insurance, and the FHA will be increasing that monthly mortgage insurance from .55% to 1.45% effective Monday, October 4.

Let’s say this program allows someone with existing financing of $350,000 at 6.25% with no mortgage insurance to refinance to $300,000 at 4.25% with mortgage insurance. The politicians and press would say this 2% rate improvement and lower loan amount would save $679 per month, which if true, would indeed be enough savings for a borrower who qualified for the refi (under FHA loan approval standards) to keep their home. But it isn’t true. When you factor in the new FHA mortgage insurance rates, the savings is $298, or 56% less savings than projected. Which means less chance that such a change would be a long-term fix.

But the FHA absolutely must raise insurance premiums because their ability to back loans that go bad is funded from FHA mortgage insurance premiums. And the fund has been depleted due to rising foreclosures in the past few years. It’s an extremely tough problem that either political party is going to face despite any election results.

Officials say between 500,000 and 1.5 million so-called underwater loans could be modified through the program, the first initiative to target homeowners who are current on their mortgage payments but are at risk of default because they have no equity in their homes. Some experts are warning, however, that the same knots that tied up prior initiatives could do so again.

Under the new “short refinance” program, banks and other creditors that write down mortgages to less than the value of the property can essentially hand off the reduced loan to the government. The process involves refinancing borrowers into loans backed by the Federal Housing Administration.

While the program puts taxpayers at risk—officials estimate one in five loans in the program could default—the government has set aside $14 billion previously earmarked for housing aid from the Troubled Asset Relief Program to cover losses.