While mortgage interest rates are at their lowest levels since 1945,
millions of mortgages that carry interest rates of 6 percent to 9
percent or even higher are not being refinanced. The reasons for
this involve Fannie Mae and Freddie Mac, the two secondary mortgage
market giants now in government conservatorships, in a central role.

The problem is perhaps best seen through the eyes of borrowers who
are unable to refinance. Each unsuccessful borrower cited below is
representative of a sizable group of unsuccessful borrowers.

Adam was turned down for a refinance because he did not meet the
new stiffer underwriting and pricing requirements set by the
agencies in their standard programs. His credit score, which was
acceptable when he got his loan before the crisis, is not high
enough to meet the new requirements.

It clearly was appropriate for the agencies to correct the
excessively liberal rules that had prevailed during the go-go
years, which contributed to the financial crisis. However, they
have reacted to their excessive liberality before the crisis by
becoming excessively restrictive in the aftermath. Their
underwriting and pricing structures are designed to maximize their
net earnings, as if they were still private firms.

Fannie and Freddie are now part of the government, and should set
their underwriting rules and pricing adjustments not to maximize
net revenue but to break even over a long time horizon.

Barbara is one of many homeowners who bought during the go-go years
and who now owes more than her house is worth -- she is
"underwater." She applied for a loan under the Home Affordable
Refinance Program (HARP) program, which was designed to make
refinancing possible for underwater borrowers who are current on
their payments and whose loans are owned by Fannie or Freddie.

Barbara is ineligible, however, because she is too far underwater.
Her loan-to-value (LTV) ratio is 130 percent, and the agencies have
set a 125 percent maximum.

A maximum LTV in the HARP programs cuts out a sizable segment of
the potential market, for no good reason. The agencies are already
on the hook for any losses on high-LTV loans, and a rate reduction
can only reduce the probability that a default will occur that
would trigger the loss.

Indeed, the reduction in expected loss from a rate-reducing
refinance is larger on a 150 percent LTV than on a 125 percent LTV.
The default rate has to fall only half as much on a 150 percent
loan as on a 125 percent loan to generate the same reduction in
expected loss.

Fannie and Freddie should scrap the LTV maximum in the HARP program,
for which there is no rational reason, thereby also eliminating the
need for appraisals on HARP loans.

Charley was turned down for a refinance under the HARP program,
although his LTV was only 120 percent, which made him eligible
under agency rules. Nonetheless, the lenders Charley approached
would not make the loan. They told him that their maximum LTV was
105 percent, and some said that it was 95 percent. Charley could
have refinanced if he knew where to go, but he didn't and gave up
the search.

I did a quick and dirty survey and found that HARP loans above 105
percent are not available from brokers or from smaller lenders who
sell to wholesalers who in turn sell to the agencies. HARP loans
exceeding 105 percent are available from only some of the lenders
who sell directly to the agencies.

Freddie Mac has a list of HARP lenders at:
http://www.freddiemac.com/cgi-bin/homeowners/relief_refi.cgi,
but it is extremely difficult to find. If Fannie has one, I could
not find it. The Freddie list has 27 lenders, 14 of which do 125
percent loans, of which only four have a wide multistate presence:
Aimloan.com, SunTrust Mortgage, Quicken Loans and RBC Bank.

Fannie and Freddie ought to do a better job of informing potential
borrowers how to find a lender who will make 125 percent HARP
loans, and they should review their policies that have discouraged
broader lender participation.

Doris's situation was the same as Charley's, including an LTV of
120 percent, with one difference. Doris's existing loan carries
mortgage insurance (MI). The lenders who turned her down told her
that the mortgage insurer had to agree to shift the MI policy to
the new loan, but would not do so in her case.

Under HARP rules, if there is no MI on the existing loan, none is
required on the new loan. If there was MI on the old loan, as in
Doris's case, it will be carried forward on the new loan, provided
the PMI firm agrees. But if the current LTV exceeds 105 percent,
they won't agree unless the new loan is being made by the existing
servicer.

Doris was not aware that only the lender servicing her loan can
shift the mortgage insurance policy from the existing loan to a new
one.

Fannie and Freddie ought to inform potential HARP borrowers who
have mortgage insurance and LTVs greater than 105 percent that
they can refinance only with their current lender, and they should
examine whether there is anything they can do to remove the PMI
roadblock.

Ethan is an underwater borrower in good standing whose loan is not
owned by Fannie or Freddie. His only possibility of a refinance is
the new FHA program I wrote about a few weeks ago, but that program
requires the existing lender to write down the balance to 97.75
percent of house value. Since Ethan is making timely payments, the
lender has very little incentive to do that.

Ethan had no say in who ended up owning his loan -- from his
perspective it was a coin toss that came up tails and made him
ineligible for HARP. The out-of-luck group to which Ethan belongs
includes a large number of subprime borrowers who meet their
obligations faithfully while paying rates up to 9 percent and even
higher.

There is no good reason why such borrowers have to be left entirely
out in the cold. While including these borrowers in HARP would
expose Fannie and Freddie to risks they did not have before, the
agencies could set payment performance requirements and charge risk
premiums large enough to protect taxpayers while still offering
many of these borrowers substantial relief.

Treasury should have the agencies develop a HARP-1 program covering
loans they do not now own that would be subject to underwriting
rules and price adjustments consistent with the government breaking
even.

The U.S. Department of Housing and Urban Development has announced
a new reverse mortgage alternative aimed at cash-strapped seniors
who are looking to reduce the up-front costs of tapping their home
equity in exchange for lower loan proceeds.

The move comes on the heels of increases in the cost of mortgage
insurance. Mortgage insurance is required on all reverse mortgages
so that the lender is protected if the senior outlives the value of
the home. It also it also protects the owner in the event the
lender went out of business.

Both issues come into play in a down real estate market where many
home are worth less than they were at the time the reverse mortgage
was issued.

A reverse mortgage historically has enabled senior homeowners to
convert part of the equity in their homes into tax-free funds
without having to sell the home, give up title, or take on a new
monthly mortgage payment. Funds obtained from the reverse mortgage
are tax-free.

The new HECM Saver is a variation of the federally insured Home
Equity Conversion Mortgage (HECM Standard), which allows owners
over 62 to stay in their homes for as long as they wish. More than
130,000 HECMs were originated last year.

According to Vicky Bott, HUD deputy assistant secretary,
implementation of the HECM Saver will reduce the amount of mortgage
insurance premium (MIP) required at closing. However, the reduced
up-front cost also reduces the maximum amount an owner can take out.

The HECM Saver will have an up-front MIP of 0.01 percent of the
maximum claim amount (the value of the home or $625,500, whichever
is less). The HECM Standard up-front MIP remains at 2 percent of
the maximum claim amount.

In addition, both products will have an annual MIP of 1.25 percent.
This is an increase in the now HECM Standard MIP, which has been
0.5 percent annually.

The HECM Saver has principal limits between 10 to 18 percent less
than the HECM Standard principal limits, thus offering consumers
the option of lower proceeds in exchange for lower costs. According
to HUD, the lesser decrease in principal limits will be for younger
borrowers and the larger for older borrowers.

The changes were made because the funds for reverse mortgages have
dwindled. The HECM portion of the overall FHA Mortgage Insurance
fund pool of funds is down significantly and no private lender has
resurfaced. Private reverse mortgage "jumbo" funds have virtually
evaporated given the present credit crisis.

According to Peter Bell, president of the National Reverse Mortgage
Lenders Association, reverse mortgages are increasingly being used
by seniors to pay off defaulted mortgages and avoid foreclosure,
thus preserving their ability to remain in their homes.

A reverse mortgage can also be an effective tool to relieve the
burden of current loan payments or moving from the home. In many
cases, homeowners use reverse mortgages to pay off existing
"forward" mortgages, thus eliminating burdensome payments on their
current mortgages and freeing up cash for living and health-care
expenses.

While reverse mortgages has been used primarily as way to keep
seniors in their homes, they have other uses as well. The Housing
and Economic Recovery Act of 2008 approved the "HECM for Purchase"
program. The move allows older homeowners to make a large
downpayment on a new home and then utilize the reverse mortgage
as permanent financing.

The same law reduced the maximum loan fee on reverse mortgages to
2 percent on the initial $200,000 of the home's value and 1 percent
on the balance thereafter, with a cap of $6,000. Previously, HECM
fees were capped at 2 percent of the home's value or the county
lending limit, whichever was lower. These fees are in addition to
the mortgage insurance premium.

If you are a senior in the market for a reverse mortgage, shop
around for the best program for you. Some lenders have reduced fees
for servicing, origination and title insurance for fixed-rate
HECMs. Lump-sum payouts, monthly draws, lines of credit -- or
combinations of these options -- are now part of the reverse
mortgage mainstream.

It may not be the best time to sell, but it might not be the worst
either. Recent economic forecasts suggest that the housing recovery
could take years. As a seller who has a strong motivation to sell,
do you try to sell now or hold on for a better market?

First consider where you want to be in 10 years. How do you
envision your lifestyle? Is your current home too big, too small,
or in the wrong location?

Homeowners intent on moving from one house to another can take
advantage of low interest rates, if they are able to sell their
current home. You'll probably sell for less than you would have
several years ago, but you may get a deal on the home you buy.

However, if you don't plan on living in your next home for the
next eight to 10 years, this might not be a good time to make a
move.

For sellers who purchased in recent years, selling requires a huge
readjustment in their expectations. Many will probably sell for
less than they paid; in some cases, a lot less. If they highly
leveraged the purchase, or refinanced and pulled out equity, they
may need to contribute cash to close the deal.

Sellers who have no cash reserves and need to sell for less than
the amount of the loans secured against the property will need
lender approval to complete a sale. This is called a short sale.
In this case, or with a foreclosure, sellers don't have the option
of buying another home until their credit is restored, which takes
about two to three years for a short sale and five years for a
foreclosure.

Some listings in prime, high-demand markets come on the market and
sell quickly, leaving other sellers in the area perplexed. Why
isn't their home selling? Why aren't they receiving bids from
multiple buyers?

Listings that sell quickly are priced right for the market. They
are homes that will work long term for the buyers, which means 10
or more years. They don't need updating; they're in move-in
condition. And, they are usually located in high-demand,
low-inventory neighborhoods. Buyers are waiting for these prime
listings and will move quickly when they come along.

HOUSE HUNTING TIP: It's frustrating for sellers whose listings
don't receive an overwhelmingly positive response, especially if
they put time and money into fixing them up for sale, and they
thought they priced right for the market. Motivated sellers will
need to accept the probability of a longer marketing period and a
lower price.

Expect low offers if your home has been on the market awhile. It's
natural for buyers to try to buy a home as inexpensively as
possible to cover for the possibility of a further downturn in the
market. Don't take it personally; counter any offer from
financially qualified buyers who make a clean offer that's not
encumbered with complicated contingencies.

It may take several offers and failed attempts to find the right
buyer. It isn't easy for most sellers to reach a successful
closing in this market. But those who stick it out can reach their
goal.

Waiting to sell could net you more for your home. But it's
impossible to know when that better time will arrive. The market
will be volatile. Good economic news will trigger a pickup in the
market. Bad news will cause buyers to pull back.

THE CLOSING: To take advantage of a pickup in the market, your
home needs to be on the market or ready to go on a moment's notice.

Cash-in refinancing means putting cash into a transaction by paying down the balance, as opposed to cash-out refinancing where you take cash out by increasing the balance.

Cash-in refinancing has become a hot topic recently because in the current market it is possible for mortgage borrowers to earn a very attractive rate of return on money invested in a balance paydown, at the same time that the returns available on other low-risk investments, such as government securities, CDs and money market funds, are lower than they have been at any time since the 1930s.

The high returns available from cash-in refinancing reflect several features of the current financial scene. Interest rates on very low-risk mortgages have never been lower, creating large spreads between those rates and the rates now being paid by millions of borrowers on their existing loans.

The problem is that the lowest rates on new mortgages are available only to borrowers who meet the risk requirements, which most do not.

These requirements include not only good credit and adequate income, but homeowner equity of 20-25 percent, which translates into loan-to-value ratios (LTVs) of 75-80 percent on new loans.

Many homeowners cannot meet the LTV requirement because of the decline in home prices that has occurred over the last four years. Further, mortgage insurance premiums on loans with LTVs above 80 percent have increased significantly for those without the very best credit.

Cash-in refinancing makes the best rates available to borrowers who would otherwise qualify for them but don’t have enough equity in their property. Paying down the loan balance reduces the loan-to-value ratio on the new loan, which reduces the interest rate, mortgage insurance premium, or both.

The balance paydown, and the lower interest rate it makes possible, reduces both the monthly payment over the period the borrower expects to be in the house and the balance that has to be paid off at the end of the period.

The principal question the borrower should ask is whether the rate of return on the money used to pay down the balance and cover the closing costs on the new loan exceeds the return on alternative investments available to the borrower.

With Chuck Freedenberg, I developed a new calculator that shows the rate of return on an investment in a loan paydown in connection with a refinance. It is calculator 3f on my website.

Here is an example: John has a 6 percent mortgage with 300 months to go and a $100,000 balance, but his house is worth only $100,000, which makes him ineligible for a refinance. However, if he pays down the balance to $80,000, he can refinance into a 4.5 percent loan with closing costs of 2 percent.

If John stays in the house for five years, the rate of return on his investment, consisting of $20,000 in balance paydown plus $1,600 in closing costs, would be 9.98 percent. The return is riskless to the borrower.

The rate of return depends on the size of the rate reduction, closing costs on the new loan, how much must be invested to get to an 80 percent LTV, and on how long the borrower expects to have the mortgage.

To illustrate: If John’s house is worth $118,000 rather than $100,000 so that he has to invest only $5,600 to get to an 80 percent LTV, his return would jump from 9.98 percent to 21.09 percent. If the new rate is 5.25 percent rather than 4.5 percent, the return would fall from 21.09 percent to 10.41 percent.

If closing costs are 1 percent rather than 2 percent, the return would rise from 10.41 percent to 15.13 percent. And if John sells the house after only two years instead of five, his return would fall from 15.13 percent to 9.45 percent. You can find the returns applicable to your deal using calculator 3f.

Readers who use calculator 3f will notice that it calculates two rates of return. The numbers cited above compare the paid-down mortgage with the current mortgage. The second return compares the paid-down mortgage with a new mortgage that does not have a paydown, and therefore will carry either a higher rate or a mortgage insurance premium.

The second rate of return is for borrowers who can refinance profitably without a paydown, and are therefore not quite sure they want to invest the money in making the refinance more attractive. The return relative to the refinanced loan without a paydown will be lower.

Suppose John’s house in the example above is worth $111,200, so that his current balance of $100,000 is 90 percent of value.

In this situation, he can refinance without a paydown by paying mortgage insurance, which I priced at $52 a month. Assuming a rate of 4.75 percent and closing costs of 1 percent with or without the paydown, the returns over five years on an investment in paydown are 14.06 percent relative to the current mortgage, and 10.75 percent relative to a refinance without paydown.

Note that if the return relative to a new loan without paydown is higher, it means that a refinance without a paydown is a loser and should be avoided.

Nancy and Les Beatty have not spent one night in their ski cabin in 2010. One of their daughters was married in June; Nancy’s family held a reunion in Taos, NM in late July; andLes plans to take time off from work to move his father into a retirement home in July, so there has been no time to get to the cabin.

“We’ve heard for years about people who don’t use their second home, and now we are those people,” Les said. “I think we would probably sell the place, but we always stop ourselves when we think about paying a capital gains tax on the place.”

One viable option is to convert the cabin to investment property status, rent it out for a couple of years and then sell it via a 1031 tax-free exchange to acquire another investment property closer to home that could produce a monthly cash flow, supplementing household income. The new property could ultimately be placed in the couple’s estate or in a charitable trust.

One of the more underestimated financial bonuses available to the average consumer is the ability to convert a primary residence or a second home into a rental property, and vice versa.

Let’s look at the Beattys’ situation from another angle. The couple converts the ski cabin to an investment property and rents it out for two years.

During that time, they hear of a bargain property in Arizona that has the amenities they require for a retirement home but they are unsure if they would truly want to live there. They could sell the ski cabin via a 1031 exchange, buy the Arizona property and rent it out.

Tax-free exchanges must involve investment properties. If you eventually decided to live in the “replacement property” of the exchange — as a primary residence or second home — it would be difficult for the Internal Revenue Service to question. In this case, that’s because the Beattys were unsure they wanted to live in the Arizona home when the exchange was made.

If an exchange is contested, the IRS will examine the “objective manifestations of your intent” at the time you conducted the exchange to determine what the intention truly was.

According to several accountants, the only gray issue is how long the property must be held as rental property before the coast is clear to deem it a primary residence. A home that has been a rental nest egg for decades is not an issue, but those that have been acquired in the past three years via a tax-free exchange can be. That’s because no specific hold times have ever been written. Remember, intent at the time of the exchange should be toward another investment property.

If taxpayers are going to convert the use of homes, it’s best to have at least two tax years in the books.  Let’s say if the Beattys were to buy an Arizona rental today, it would best to keep it a rental at least through 2011. That way, the conversion would not appear on a tax return until the 2011 return, and then actually be viewed sometime in 2012.

Since the Arizona home was acquired via a tax-deferred exchange, the Beattys will have to wait five years from the date of purchase to claim the $500,000 ($250,000 for a single person) tax-free exemption on the sale of a principal residence.

Typically, in order to qualify for the $500,000 exclusion ($250,000 for single persons) homeowners must have owned and used the property as a principal residence for two out of five years prior to the date of sale. And, the owner must not have used this same exclusion in the two-year period prior to the sale.

Legislators were concerned about tax abuse and adopted the five-year law for exchange properties because it “balances the concerns associated with these provisions to reduce this tax shelter concern without unduly limiting the exclusion on sales or exchanges of principal residences.”However, a 2004 law limited the scope because legislators did not believe the principal residence exclusion “was appropriate for properties that were recently acquired in like-kind exchanges.” When homeowners convert the exchange property into a principal residence, the taxpayer often shelters some or all of the gain.

You have tax options with both your investment properties and your primary residences. Make sure you understand all the possibilities before you sell.

Fannie Mae says it will begin fining loan servicers who take too long to complete foreclosures once it’s been determined that delinquent borrowers don’t qualify for a loan modification or other alternatives like short sales.

The fines — or “compensatory fees” — will be assessed when loan servicers can’t provide a reasonable explanation for failing to meet timelines for completing routine foreclosures that vary from state to state, Fannie Mae said in a bulletin to servicers.

The time allotted to complete a foreclosure, starting from the referral of a loan file to an attorney or trustee until the date of a foreclosure sale, varies from as little as 60 days in Georgia, Michigan, Missouri, Tennessee, Texas, Virginia and West Virginia, to 300 days or more in Illinois, Maine, New Jersey, New York, Vermont and Wisconsin.

The foreclosure timelines Fannie Mae has established for the four states hit hardest by foreclosure during the downturn fall in between: 120 days in California and Arizona, 150 days in Nevada, and 185 days in Florida.

Fannie Mae said the foreclosure schedules it’s established for each state represent the time “typically required for routine, uncontested foreclosure proceedings, given the legal requirements of the applicable jurisdiction.” The timeline in Florida, for example, was extended by 35 days to allow for a state-mandated mediation process.

Fannie Mae promised it “will not impose compensatory fees for delays beyond the control of the servicer, such as unavoidable mediation or court delays, or sales delays by sheriffs or other selling officers.”

When fines are levied, they will be based on the outstanding principal balance of the mortgage loan, the rate of return paid to investors in mortgage-backed securities backed by the loan, the length of the delay, and any additional costs directly attributable to the delay.

According to mortgage data aggregator Lender Processing Services, an estimated 2.02 million homeowners were in foreclosure in July nationwide. Another 5.02 million homeowners were behind on their mortgages.

On average, borrowers in foreclosure were 469 days behind on their mortgage payments, up from 351 days a year ago and 196 days in January 2009, LPS said.

Properties that are vacant and held off the market, combined with whatever portion of homes with delinquent mortgages that are not currently listed for sale, “represent a shadow inventory putting downward pressure on both home prices and rents,” Fannie Mae warned in the company’s most recent quarterly report to investors.

According to the report, 4.99 percent of the roughly 9 million single-family loans securitized into mortgage-backed securities guaranteed by Fannie Mae were seriously delinquent or in the foreclosure process as of June 30 — about 450,000 loans.

Of those, about 170,000 were in foreclosure. About two-thirds of seriously delinquent loans had been delinquent for more than 180 days.

In the first half of 2010, Fannie Mae’s loan servicers negotiated 276,059 loan workouts — more than three times as many as the same time period the year before.

Fannie Mae’s loan servicers also signed off on 38,841 short sales and deeds-in-lieu of foreclosure during the first half of 2010, a 171 percent increase from the same period a year ago that nearly matched the total for all of 2009.

Fannie Mae nevertheless acquired 130,767 properties through foreclosure in the first half of the year, up from 57,469 during the first half of 2009.

At the end of the foreclosure process, loan servicers schedule properties for auction. If nobody bids for a property, or if the bids that are received fall short of the properties’ estimated worth, Fannie Mae takes possession of the home and handles its resale.

The company was only able to sell 87,612 of the properties it acquired through foreclosure in the first half of 2010, leaving it with an REO inventory of 129,310 homes valued at $13 billion.