The Federal Housing Administration (FHA) is opening the door for conventional borrowers with negative equity to refinance into government insured loans.

The agency recently issued guidelines for its FHA Short Refinance Program, which requires investors to accept writedowns on first and second mortgages (if necessary) to a combined loan-to-value ratio of 115%. The first mortgage must be written down by at least 10% to qualify.

Department of Housing and Urban Development (HUD) deputy assistant secretary Vicki Bott said there is a lot of excitement in the marketplace about the program, which was first proposed in March. She expects some FHA lenders will able to start originating “short refis” on Sept. 7—the effective date.

However, even though FHA is open to refis where a principal writedown may occur on a nongovernment loan, the HUD is shutting the door on conventional borrowers with high LTV mortgages and second liens from using its regular FHA refinancing program.

Starting Sept. 7, the maximum combined LTV for a rate-and-term refinance will be 97.75%. On cash-out refinancings, the maximum CLTV is 85%, according to Mortgagee Letter 2010-24.

FHA has served as an easy way for conventional borrowers to refinance over the past three years—particularly as Fannie Mae and Freddie Mac tightened underwriting guidelines and increased loan level fees.

During the first three quarters of fiscal year 2010, which ended June 30, FHA insured 435,949 newly refinanced loans, which represents 33% of its business.

Over 50% of those transactions involve conventional borrowers refinancing into a FHA loan.
FHA made the change to reduce its risk and eliminate the "unlimited CLTV ratio" that was first introduced in 2007 during the subprime meltdown to give borrowers a refinancing option.

"We are bringing the guidelines back into the norm," Bott said, with a carve-out for the FHA Short Refinance Program.

HUD data based on lender reporting show only a small amount of FHA refinanced loans have second mortgages.

But FHA officials are getting some "push back" from lenders about the tight CLTV limits.
FHA officials tried to assess the impact before making the change.

"If lenders feel it has an impact then there was incorrect reporting going on," Bott said in an interview.

Meanwhile, it appears that borrowers with high LTV mortgages owned or guaranteed by the Fannie and Freddie will not have access to the program.

Keefe, Bruyette & Woods equity analyst Bose George said the new FHA program is geared toward refinancing private-label mortgages, not necessarily GSE product. FHA borrowers are not eligible for short refi program.

And based on a recent statement by the Treasury Department, “it appears the GSEs will not approve write downs on the loans they guarantee,” George said.

HUD estimates 500,000 to 1.5 million homeowners could quality for the FHA short refi program. "They will be lucky to end up at the low end of that range," the KBW equity analyst said.
He expects investors will accept writedowns only on the highest LTV loans that are likely to go delinquent within six months.

"The problem is the investor and second lien holder has to agree to a writedown," George said. "I think very few investors will be interested—maybe a couple of hundred thousand."
Underwater borrowers with GSE-guaranteed loans can refinance under the Home Affordable Refinance Program (HARP).

HARP allows current borrowers with LTVs above 80% to 125% to refinance at a lower rate without purchasing mortgage insurance.

However, the HARP program has not gained much traction above a 105% LTV level.
Freddie completed 40,700 HARP refinancings in the second quarter, but only 3,200 loans had LTVs above 105%.

Fannie completed 47,000 HARP refinancings in the second quarter, but the GSE did not break out the higher LTV refinancings in its second quarter securities filing. Only 2,100 of Fannie's HARP refinancings in the first quarter had LTVs above 105%, according to the GSE regulator.

"If they want this to work," George said, the GSEs would waive representations and warranties and reduce the risk-based pricing on the HARP loans. "The reps and warranties are key—they need to waive that for lenders," he said.

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