Liberty Street Economics

« | Main | »

July 15, 2013

Improving Access to Refinancing Opportunities for Underwater Mortgages

Joshua Abel and Joseph Tracy

Since the onset of the housing crisis, a focus of policymakers has been to help underwater homeowners lower their monthly mortgage payments by refinancing, principally through the Home Affordable Refinance Program (HARP). This enables households to commit more money to consumption, debt reduction, and saving. Lower monthly payments also decrease the risk of mortgage defaults, allowing homeowners to stay in their homes and reducing expected losses for mortgage guarantors Fannie Mae and Freddie Mac, which remain under conservatorship of the Federal Housing Finance Agency. Stanching the flow of defaults also helps to firm up the housing market and, therefore, the economy as a whole. In this post, we examine some simple adjustments to HARP that would help to continue the program’s recent success and provide additional support to the housing market recovery—an undertaking that has added significance with the recent increase in mortgage rates, which could hamper refinancing activity moving forward.


Recent home price appreciation has benefited homeowners in most parts of the country. However, millions of homeowners still find themselves with little or no equity in their homes, the result of the earlier steep decline in home prices. Without sufficient equity, it can be very difficult to refinance, which means that these homeowners cannot take advantage of the current low interest rate environment.

HARP is designed to allow borrowers who are current on their payments and whose existing mortgages are guaranteed by Fannie Mae or Freddie Mac to refinance even if their loan-to-value (LTV) ratios are above the 80 percent level that is typically required for prime mortgages. Since HARP’s inception in April 2009, about 2.5 million homeowners have used the program. Much of this success has come since a 2012 redesign (the so-called HARP 2.0). Among other things, this redesign removed the 125 percent LTV limit on HARP refinances, opening the program to borrowers more deeply underwater. The chart below showing a sharp uptick in participation in 2012 makes clear how important that policy change was.

Monthly-HARP

It could be time to consider further program changes. Currently, HARP can only be utilized by borrowers whose mortgages were obtained by Fannie Mae or Freddie Mac by June 1, 2009. Additionally, borrowers are only allowed to use HARP once, meaning that borrowers who have already done so are now ineligible. We find that altering these rules could heighten refinancing activity substantially. To evaluate the potential benefit from relaxing these two program restrictions, we take a random sample of loans and select those that are eligible (backed by Fannie Mae or Freddie Mac, current on payments, and other criteria). We then say that a loan is in-the-money to use HARP if refinancing would decrease the monthly payment enough so that the borrower can recoup the costs of refinancing, such as the appraisal cost and program fees, within three years. We repeat this exercise using different eligibility rules, such as moving the cutoff date from June 1, 2009, and allowing “reHARPing” (refinancing a second time under HARP).

The table below summarizes our results as of February. We estimate that about 1.5 million borrowers are eligible and in-the-money for HARP under current guidelines. Shifting the cutoff date—to 2010, 2011, 2012, and then removing it entirely— adds substantially to this number, though at a decreasing rate. Our analysis shows that eliminating the cutoff date entirely would add 530,000 in-the-money borrowers, an increase of over 30 percent. If reHARPing were also allowed, this increase would climb to over 55 percent.

Abel-table

Note that on the whole, the reduction in monthly payments for these additional borrowers would be lower than for those that are currently eligible, due to the fact that mortgage rates have declined substantially since 2009, meaning their contract rates are already somewhat lower. However, an extra $200 per month could make a significant difference for many individual homeowners and for the macroeconomy, when aggregated. Although heightened refinancing activity will lower returns for investors in agency mortgage-backed securities, the macro effects of additional money in homeowners’ pockets more than offset those losses, meaning that refinancing is not simply a zero-sum transfer from investors to borrowers, as discussed in an earlier post.

Furthermore, there is reason to believe that these program changes could provide a bigger boost than our numbers imply. Consider that the table above provides estimates of how many borrowers have incentive to refinance, not how many will actually do so. Predicting the “take-up” rate—the fraction of in-the-money borrowers who will actually complete a HARP refinance—is a difficult exercise. However, it seems reasonable to believe that the take-up rate among newly eligible borrowers (if, say, the cutoff date was moved) will be a lot higher than for those who are already eligible, but have so far decided not to participate despite the financial incentive to do so. There are various reasons why someone may not participate: lack of information about the program, lack of financial sophistication, or plans to move from the house in the near-term, among others. All of these are unobservable in the data, but eligible borrowers, by not responding to the incentive up to this point, have revealed that some or all of these effects may be at work. Others have not used HARP simply because they have not been allowed, and it is likely that many will rush to do so when given the chance. In fact, there’s evidence for this in our first chart: borrowers with LTV ratios greater than 125 percent became newly eligible in 2012, with a tremendous influx of these borrowers into the program soon after.

The recent improvement in the housing market is welcome news, but it has not erased the negative equity problem brought on by the housing bust. One of the consequences is that many borrowers are still trapped paying interest rates far above the current market rate. HARP is a sensible response to this problem for borrowers with agency mortgages, and changes to the HARP program in 2012 increased the effectiveness of the program. Some additional changes to that program could build on the recent success of HARP and provide ongoing support for the housing market recovery.


Addendum
(July 18, 2013)

The above analysis assumed that a borrower could refinance into a thirty-year fixed-rate mortgage with a rate of 4.0 percent. After receiving reader comments, we have updated the table assuming that a borrower now could refinance into a mortgage rate of 4.5 percent. This 50 basis point increase in the mortgage rate reduces the impacts associated with each proposed program change. For example, removing the origination date deadline would now add an estimated 264,000 additional in-the-money borrowers, a 50 percent reduction from the earlier 530,000. For those borrowers who remain in-the-money, the higher assumed mortgage rate also reduces the extent to which a HARP refinance will lower their monthly mortgage payment. Again, looking at the case of removing the origination date deadline, the reduction in the average monthly payment is an estimated $161, a 12 percent decline from the earlier $182.

Comments_table_wider

Disclaimer
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.


Abel_joshuaJoshua Abel is a former research associate in the Research and Statistics Group of the Federal Reserve Bank of New York.

Tracy_josephJoseph Tracy is an executive vice president and senior advisor to the Bank president at the Federal Reserve Bank of New York.

Comments

Feed You can follow this conversation by subscribing to the comment feed for this post.

Thank you for your comments. The addendum above updates the table using a higher interest rate. See “Revised Program Change Analysis.”

I assume that the table you show is based on Feb 2013 primary mortgage rates. The primary rate is now at least a full percentage point higher than it was back in February. As such, the incremental benefit of expanding HARP eligibility would be much lower now. Do you guys have an updated table? Thanks.

The comments to this entry are closed.

About the Blog

Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.

The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Asani Sarkar, all economists in the Bank’s Research Group.

Liberty Street Economics does not publish new posts during the blackout periods surrounding Federal Open Market Committee meetings.

The views expressed are those of the authors, and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.

Economic Research Tracker

Image of NYFED Economic Research Tracker Icon Liberty Street Economics is available on the iPhone® and iPad® and can be customized by economic research topic or economist.

Economic Inequality

image of inequality icons for the Economic Inequality: A Research Series

This ongoing Liberty Street Economics series analyzes disparities in economic and policy outcomes by race, gender, age, region, income, and other factors.

Most Read this Year

Comment Guidelines

 

We encourage your comments and queries on our posts and will publish them (below the post) subject to the following guidelines:

Please be brief: Comments are limited to 1,500 characters.

Please be aware: Comments submitted shortly before or during the FOMC blackout may not be published until after the blackout.

Please be relevant: Comments are moderated and will not appear until they have been reviewed to ensure that they are substantive and clearly related to the topic of the post.

Please be respectful: We reserve the right not to post any comment, and will not post comments that are abusive, harassing, obscene, or commercial in nature. No notice will be given regarding whether a submission will or will
not be posted.‎

Comments with links: Please do not include any links in your comment, even if you feel the links will contribute to the discussion. Comments with links will not be posted.

Send Us Feedback

Disclosure Policy

The LSE editors ask authors submitting a post to the blog to confirm that they have no conflicts of interest as defined by the American Economic Association in its Disclosure Policy. If an author has sources of financial support or other interests that could be perceived as influencing the research presented in the post, we disclose that fact in a statement prepared by the author and appended to the author information at the end of the post. If the author has no such interests to disclose, no statement is provided. Note, however, that we do indicate in all cases if a data vendor or other party has a right to review a post.

Archives