In October, President Obama unveiled part of his plan to try to help the ailing housing market. Specifically, he is expanding access and reducing barriers to his 2009 HARP program that allowed homeowners to refinance their mortgages at lower rates. However, takeup was minimal because underwater loans were not able to participate, and because upfront fees were high.
The October proposal deals with some of these concerns. It eliminated the need for costly appraisals and allowed mortgages of up to 125% loan-to-value to participate. But Fannie Mae and Freddie Mac are dropping upfront fees only if borrowers reduce the term of their mortgage. From the Wall Street Journal:
The changes being prepared by federal officials should boost refinancing because they will let banks avoid the risk of any “buy-back” on a HARP mortgage as long as borrowers have made their last six mortgage payments and they prove that they have a job or another source of passive income. They are also set to reduce loan fees that Fannie and Freddie charge. The fees will be waived on borrowers that refinance into loans with shorter terms, such as a 15-year mortgage.
Unfortunately, a shortened maturity would go directly against the intended stimulus effects of this program, because this would increase monthly payments.
Imagine that you had a $200,000 mortgage with a 30 year term at 6.50%. That’s a monthly payment of $1264. In order to refinance without Fannie and Freddie imposing upfront fees—that you can’t afford right now—you would need to reduce the maturity to 15 years. Even if you could refinance at 3.30%–the current 15 year rate—this would imply a monthly payment of $1410, higher than it was before. Obviously, this is still a good deal for the borrower because he would pay much less over the course of the loan. But it does not give the borrower extra money to spend to consume goods and services right now to stimulate the economy.
As a general rule, if your original mortgage rate was less than 7.6%, your monthly payment would increase with this type of refinancing—and reduction in the mortgage’s maturity. Because mortgage rates have been lower than 7.6% since 2000, many who refinance into such mortgages will fall into this group and thus have a higher burden in the short run.
So while the borrower will benefit from the shortened payment time, Obama’s plan might increase monthly payments for many homeowners, undermining the desired stimulus to the U.S. economy.