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Refi Rejections On The Rise

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:,
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:, 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

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

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

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

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