New FHA Program to Provide Relief for Underwater Homeowners

Foreclosures represent possibly the greatest threat to the housing market, which many economists fear is on the verge of a devastating double dip.  According to a RealtyTrac report, foreclosures are projected to rise to 4.5 million this year.  There were 2.8 million foreclosures last year.  Distressed properties are selling at bargain rates, and are bringing down home values as well as stifling new home construction, which is a huge driver of employment in the United States.

The Obama Administration is set to announce an expansion to efforts to combat the foreclosure epidemic. In addition to modifying the much criticized Home Affordable Modification Program (HAMP) the White House intends to introduce a new initiative through the Federal Housing Administration (FHA) which would attempt to address some of the major causes of foreclosure: unemployment and declining equity.  Borrowers who are underwater (those who owe more on their loan than their home is worth) are defaulting at epic rates.  Between 20-25% of borrowers owe more on their mortgage than their home is worth.

Whereas HAMP is designed to help borrowers who are already delinquent on payments, the FHA program will target borrowers who are current on their mortgage and would be able to qualify for FHA loan insurance if their principle is reduced.  Lenders would be required to reduce loans by 10% (or more) until the loan is equal to 96.5% of the property value.  Borrowers would than be able to refinance into an FHA-insured loan.  Lenders would lose money on the front end, but would shift the risk of foreclosure to the FHA (which is of course funded by taxpayers).  Investors would likely cut their losses, as they stand to lose far more from foreclosures than they would writing off some amount of loan principal.

A second portion of the program would would enable the unemployed to make reduced payments, or no payments for a three to six month period.

For homeowners with second mortgages, the proposal would reduce the total debt to a maximum of 115% of the value of the home. Investors holding second liens will be incentivized to write down loans so borrowers can qualify.  Many of these second lien mortgages are valueless in reality, as it stands investors that hold them stand to take total losses in the event of widespread foreclosure.

The program would be funded by $14 billion from the Troubled Asset Relief Program (TARP), $75 billion of which is already earmarked for mortgage relief.  Critics of the proposal say that if the program is not successful, a wave of foreclosures could effectively bankrupt the FHA and leave taxpayers on the hook for billions of dollars worth of bad loans.

Lenders are concerned that the program would encourage those who can afford their mortgage payments to default in order to receive a reduced loan balance.  However, these same lenders stand to take massive losses from increasing foreclosures.

What do you think about the newest efforts to help the housing market?  Join the discussion below.