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Rewards For Responsible Homeowners

There are incentives for consumers to buy homes. There are programs for those in trouble to modify their loan terms. What about tossing a bone to those borrowers who have never missed a payment but also could use a break?

For example, I was recently contacted by a couple who are three years into an interest-only, adjustable-rate mortgage (ARM) that has its interest rate fixed for the first 10 years. The loan carries a prepayment penalty if the couple were to refinance the loan within the first five years of its term.

The prepayment addendum, known in the loan industry as a “soft” prepay because no penalty is assessed if the couple sells the home, stipulates that a refinance could cost an amount equal to six months of interest payments.

While the couple (let’s call them Couple No. 1) understood the agreement when they signed it, they did not anticipate other borrowers with inferior credit and poor payment histories (let’s call them couple No. 2) getting a better deal. It seems that lenders — or the institution that now owns the loan — are willing to help only when they fear they will be taking on a negative-equity situation and end up receiving less than what the home is worth.

For example, Couple No. 1 has a loan of $440,000 at an interest-only rate of 6 percent. Their intent was to refinance to a 30-year fixed-rate loan at 5 percent or a 15-year fixed-rate loan at 4.75 percent. They did not want to take any more additional “cash back” or increase the loan size in any way. They simply wanted to get out of the interest-only loan, begin an amortizing loan and perhaps lower their monthly payments.

Their lender, with whom they hold three checking and savings accounts, said the new payments on the amortizing loan would be more than the current payment. However, there was no way that the investor that bought the mortgage (Bank of New York) would be willing to waive the prepayment penalty.

The reason given was that there was no incentive to do so — the home had plenty of equity and if the borrower defaulted, the bank could sell the home and be repaid all of the outstanding mortgage, plus fees and expenses.

Conversely, Couple No. 2 had a loan balance of $285,000 on an option ARM. They had made minimum payments on the loan, meaning the amount they had paid had not covered the interest portion of the loan. They already owed more money than they had borrowed (also known as negative amortization).

In addition, they had missed three payments in the past 24 months. When the couple applied for a refinance, the lender agreed to waive the prepayment penalty because the bank did not want to take the house back in the event the couple defaulted.

The concept of “fair” is off the table — and has been for a long time. The question now becomes: What will lenders do to retain good customers? For example, when the prepayment penalty period comes to an end, why would Couple No. 1 choose to return to the same lender for another loan? What did this lender actually do to keep these terrific customers from going to another lender on the street?

A year ago, the National Association of Realtors, the largest trade group in the world with 1.2 million members, offered a solution to the housing dilemma. NAR presented Congress with a Four-Point Housing Stimulus Plan to help stabilize the housing and mortgage markets. The crux of the package suggests using $130 billion of the $700 billion federal bailout funds on housing, specifically earmarked for an interest-rate buydown and more tax credits.

That buydown would be a one-percentage-point interest-rate buydown on fixed-rate loans for all buyers. The reduction reportedly would have resulted in approximately 840,000 additional home sales and reduced the inventory of homes by as much as 20 percent. The buydown offer would be available for a specific time period.

The incentives that became reality were an $8,000 first-time homebuyer tax credit and a new existing homeowner tax credit of $6,500. As previously stated, the amount of the “existing homeowner” credit equals the lesser of: (1) $6,500, or (2) 10 percent of the price of the replacement home, or (3) $3,250 for a buyer who uses married-filing-separate status.

To qualify, the buyer must have owned and used the same home as a principal residence for at least five consecutive years during the eight-year period ending on the purchase date for the replacement principal residence. If married, the spouse also must pass the consecutive-year test. Homes valued at $800,000 or more do not qualify.

Still, foreclosures are expected at a record pace. Why not slow the foreclosures, curtail high inventories and make more mortgage money available? Lenders can do that by offering good customers a buydown in interest rates, keeping them in their homes.