(CNSNews.com) – President Obama during his State of the Union speech Tuesday debuted a new plan aimed at fixing one part of the housing crisis, saying that he would soon send Congress a bill to help some people refinance their mortgages.
Obama said he was sending lawmakers “a plan that gives every responsible homeowner the chance to save about $3,000 a year on their mortgage, by refinancing at historically low interest rates. No more red tape. No more runaround from the banks.”
The president proposed to pay for his plan by taxing banks.
“A small fee on the largest financial institutions will ensure that it won’t add to the deficit, and will give banks that were rescued by taxpayers a chance to repay a deficit of trust.”
Obama went on to say that there would be “no bailouts, no handouts, and no copouts,” going forward for the financial industry.
However, his mortgage plan would essentially be a bailout for the struggling homeowners it purports to help.
Typically, refinancing is not much of a problem, provided homeowners are current on their payments and have decent credit. However, it is nearly impossible for homeowners whose mortgage is worth more than the home it’s based on.
This is because there is no financial benefit for banks to give one of these so-called “underwater” homeowners a new loan, as it would basically amount to forgiving part of the previous debt. Since the homeowner must borrow against the house – which has dropped in value – a bank would essentially be giving away the difference between the old mortgage’s value and the new mortgage’s value.
A government program allowing underwater homeowners to refinance their loans would constitute a bailout, essentially forgiving large amounts of debt they currently owe.
Currently, interest rates on 30-year fixed mortgages are approximately four percent – a historically low number. Allowing an underwater homeowner to get a new loan with a lower interest rate would result in much lower repayments.
Unnamed White House officials have been quoted as saying the plan would allow underwater homeowners to refinance and obtain new loans guaranteed by the Federal Housing Administration (FHA).
Currently the FHA is prohibited from new loans to underwater homeowners because they have no financial incentive to repay the loans due to the reduced equity in the home: Because their homes are worth far less than their mortgage, borrowers face a financial incentive to default on their loans, to escape paying far more than the home is worth.
The new tax on banks would presumably cover the costs the FHA would be forced to pay to make up for the losses from underwater homeowners who default.
The new program mirrors one launched in 2009 that allows underwater borrowers, whose loans are owned or guaranteed by government mortgage giants Fannie Mae and Freddie Mac, to refinance. That program has largely been unsuccessful – so much so that the administration had to lower its standards last October to allow more homeowners to qualify.
That change allowed homeowners whose mortgages were worth more than 125 percent of the home’s value to refinance. Previously, only those with mortgages worth 125 percent or less of the home’s value could refinance their loans.
The administration has not indicated whether there will be a similar cap on its new program. However, a program without a cap would be far riskier for the government than one that limited how far underwater homeowners could be.
If the administration does use the FHA, the program would work similarly to the way current FHA loans work. Private banks would handle the refinancing, with the FHA guaranteeing the new loans against default and bearing the costs should a borrower renege. In theory, banks could offer lower interest rates because they would not bear the risk of default; the government would.
However, banks would still lose money on the deals, because they would be giving up the difference between the old and new mortgages. It is not yet clear exactly how the administration would convince the banks to take the losses or how it would pay for some kind of subsidy to incentivize the banks to refinance the loans.
If the administration tried to pay banks to refinance underwater loans – as it has in the past with the Home Affordable Modification Program (HAMP) – the program would amount to a double bailout – the first being that of the underwater borrowers and the second the banks whose losses are being covered by the government.