Refinancing America's Mortgages

One of the recommendations President Obama outlined in his speech to Congress this evening was the notion of facilitating homeowners' ability to refinance their mortgages.  With the significant decline in the term structure of US interest rates, conventional 30 year mortgage rates are currently averaging around 4.125%.  For a homeowner with a $300,000 mortgage and a current interest rate of 6%, refinancing at current rates would translate to a pre-tax monthly savings of approximately $250 or $3000 per annum. 

The problem for many of these homeowners is that they don't have sufficient equity in their home to pass the credit underwriting criteria to refinance their property.  A simple example: 6 years ago, Samantha Treesdale purchased a home for $360,000 with a down payment of $60,000 with the balance financed thru a 30 year fully amortizing mortgage with a 6% interest rate.  With the decline in real estate prices, the property is currently appraised at $280,000, a full $20,000 below her current mortgage balance.  Result: no bank will  make her the new loan for $300,000 on collateral valued at $280,000.

Fannie Mae, Freddie Mac and Ginnie Mae are the US government agencies that, between them, guarantee the payment on close to $5 trillion in mortgage balances.  The idea that is being floated is that, since, the credit risk of these borrowers is already effectively on government balance sheets, allowing these same borrowers to refinance even though they are upside down on their real estate equity does not change the lender's risk profile. That lender is ultimately you and me,  i.e. the US tax payer.  In fact, one could argue that by lowering the borrower's payment, he or she is more likely to stay in their home and not walk away from their home and add to the supply of distressed properties.

The proposal's appeal is that it would have a stimulative impact on the economy, effectively putting hundreds if not thousands of dollars back in consumer pockets and would have no direct impact on the federal budget.  It would also improve the creditworthiness of many borrowers since with a lower payment, their debt to income ratios would decline.

This sounds like a complete win/win but unfortunately, there are some losers.  The main losers in this equation are the current investors holding these mortgage securities who will effectively see their investment returns decline.  A refinanced mortgage translates into a prepayment to the lender who then has to redeploy his capital at lower rates.  Additionally, one could argue that an arbitrary government intervention into one of the world's largest capital markets will anger investors who in turn will demand a higher return to compensate them for unpredictable government intervention in the mortgage market.  Over the long run, so the argument goes, mortgage rates to all borrowers will rise.  Finally, only borrowers whose mortgages are guaranteed by one of the US agencies could take advantage of this program.  Borrowers whose mortgage did not originally qualify for agency securitization would not have these refinancing options.


The proposal to streamline refinancing for agency guaranteed mortgages is not without winners and losers.  That said, at a time of growing concerns of a double-dip recession and where policy makers have a limited set of stimulative tools to address the nation's economic problems, the arguments for streamlined agency mortgage refinancing are arguably compelling.