How Much Refinancing?by Joseph E. Gagnon | October 27th, 2011 | 09:26 am
In my October 24 RealTime column, "The Last Bullet," I argued that the combination of serious reform of the Home Affordable Refinance Program (HARP) and an aggressive Federal Reserve program to hold down the mortgage rate would spark a refinancing boom that could save borrowers as much as $60 billion to $80 billion per year. This contrasts sharply with the estimate [pdf] of the Federal Housing Finance Agency (FHFA) that its announced reforms might help 1 million borrowers to refinance, which would imply annual savings of well under $10 billion per year.
I do not know how FHFA reached its estimate.1 I hope it does not imply that the details of FHFA’s proposal—to be released by November 15—will fail to deliver on the promising principles expounded in the initial announcement. Of special importance is the decision to waive "certain representations and warranties" that participating lenders must make, including on the original loans. These reps and warranties are widely agreed to be the main stumbling blocks to success for HARP to date, as banks have been reluctant to make them for all but the most creditworthy borrowers.
A serious reform of HARP must give considerable assurance to banks that they will not be held liable for errors made by the previous lenders. It is important to remember that HARP eligibility is restricted to loans that are already guaranteed by the federal housing agencies, that have been seasoned—or in existence without major problems for at least two and a half years, and that are fully up to date in their monthly payments. The refinancing of these loans should be as close to automatic as possible. As FHFA noted, lower monthly payments will make it less likely that HARP borrowers will default in the future, and thus will reduce the government’s credit risk.
An important element of successful HARP reform that was not addressed by the FHFA announcement is getting the word out to borrowers. That is why my proposal urged FHFA to direct Fannie Mae and Freddie Mac to inform all borrowers of their eligibility directly. Also, the banks and the housing agencies should apply refinancing standards that are no tighter than—and possibly easier than—the HARP standards for those borrowers who meet the HARP requirements but have loan-to-value ratios below 80 percent.
The other important element of my proposal was for the Fed to hold down 30-year conforming mortgage rates to a range of 3 to 3.5 percent through the end of 2012, with even lower rates for 15-year and adjustable-rate loans. These rates are at least 50 basis points lower than the rates on every federally guaranteed mortgage in existence, with many borrowers able to save 300 basis points or more. These low and stable interest rates, combined with relaxed standards for refinancing of loans that are already guaranteed, should spark the largest refinancing boom in history. The closest previous example is 2003, when 35 percent of all mortgages were refinanced following a decline in the mortgage rate of about 200 basis points. Under my proposal, the conditions for a refinancing boom would be even more propitious in 2012, with a 300 basis point decline in the mortgage rate since 2008, a large backlog of mortgages that were not able to be refinanced over the past two years, and a public information campaign to raise awareness of this opportunity. Altogether, it is likely that 50 percent or more of federally guaranteed mortgages could be refinanced in 2012, totaling at least $3 trillion, with savings to borrowers of $60 billion to $80 billion per year.
Finally, to maximize the macroeconomic benefits of low mortgage rates, bank regulators and the housing agencies should encourage lenders not to apply tougher standards for new prime borrowers than existed before the Great Recession. As Lawrence Summers noted recently, these standards appear to have increased substantially despite the fact that one major source of risk, falling home prices, is much lower going forward than it was in the past. Conventional prime mortgages were not the cause of our financial crisis, and applying unrealistic standards now retards our recovery and does not make the banks or the housing agencies healthier.
1. A study by the Congressional Budget Office, [pdf] cited in my previous column, estimated that HARP reform would lead to nearly 3 million additional refinancings based on assumed interest rates more than 1.5 percentage points higher than those that currently prevail. At today’s interest rates, the effect on refinancing would be much greater.