No. of Recommendations: 2
This is the question I posed to a Fannie Mae official (who to be discreet will remain nameless) in 2012.

I’m trying to determine the Agencies’ rationale for not allowing the payoff of an existing 2nd with a HARP [Home Affordable Refinance Program] loan. Many prospective borrowers ask me about this and I just don’t know what to tell them. It makes no sense--to me at least--not to be able to pay off a 2nd with a new 1st, especially if the borrower has always made timely payments.

Fannie Mae's response:

The premise is that the HARP loan is a higher risk loan that would not otherwise be approved on its own, by any lender in the market, due to low or negative equity, or other high risk factors. The reason the GSEs [Government Sponsored Enterprise] will refinance these loans as HARP loans is that they already have the credit risk on the loan, so refinancing to a lower rate but maintaining the same UPB [unpaid principal balance] will not increase the GSE's risk position. To pay off a second, the GSE's existing first lien would have to be increased by this amount, so the result is increased risk exposure to the GSE. This would be a windfall to second lien holders who in many cases would be 100% wiped out in a foreclosure, but then recover 100% of their funds with no future risk exposure if their second lien was paid off in a refinance. This effectively shifts all the risk from the second lien holder to the first lien holder.

Borrowers can pay off seconds with a new first, but the new higher UPB first lien loan has to be able to stand on its own as an acceptable credit risk, so the new loan would have to meet today's regular underwriting criteria for a cash-out refinance, or a rate/term refinance, depending on the eligibility criteria of the proposed new loan.

We certainly welcome all feedback and thoughts on how to make these programs more effective. I hope the above information is helpful.

I further asked:

I feel that in developing policy that drives these recovery programs, the em-PHA-sis has been placed on the wrong syl-LA-ble. That is, the American taxpayer has borne the brunt of the current economic situation. They will be paying the cost of bailing out Wall Street and the GSEs for generations to come. Therefore, anything that can be done to ease their burden should be done, with the needs of Wall Street secondary.

For example, I understand that paying off a second may be considered a windfall to second lien holders who would otherwise be wiped out in foreclosure. However, that must be counter-balanced by the benefit of payment relief to the American taxpayer. An economic recovery can’t fully take place unless and until the American taxpayer is helped to at least the extent that Wall Street has been helped.

Furthermore, since HARP 2.0 eliminates the maximum LTV/CLTV [loan-to-value/combined loan-to-value], it hardly matters if the UPB is increased by the amount of a second lien except in the collective consciousness of the GSEs, which seems to begrudge the relief of risk to the second lien holder. Again, legislators should (in my opinion) first look to the needs of the American taxpayer when developing policy of recovery programs. A consolidated new first lien at historic interest rates would not only provide economic relief to millions of homeowners, but also convey the impression that the government understands the equity dilemma of the American people and is seeking ways to ease their burden. Indeed, would not a lower combined mortgage payment mitigate risk of default to the first lien holder? Yes, it would.

To which Fannie Mae responded in conclusion:

You raise excellent points. From the perspective of protecting the interests of taxpayers, many second liens were funded and are presently owned by Wall Street and mega banks. As second liens, many originally funded at very high CLTV. These lenders knew they were taking on much higher risk in return for much higher interest rates. They made a bet that has not turned out so well. If these loans were paid off by HARP refinances, then the Wall Street and mega banks would have earned high yields on the second liens, and yet pass onto the taxpayers their future credit losses of these bad bets if their loans were paid off by a GSE refinance. This would amount to a GSE/taxpayer bailout of the lenders who made these second liens, as the risk of these loans going forward would now be with the GSE's/taxpayers. The lenders who made the liens would have enjoyed the high interest rates during the life of the loans, then be paid off 100% for the risky investments they made, while all future HARP loans that default would have even greater losses to the taxpayers, since the GSE/taxpayer exposure on each new loan default would be higher.

I agree that we have to find ways to improve the total picture for borrowers, so that their entire situation improves and they improve their ability to stay in their homes, which is our primary focus. A HARP loan will provide significant payment relief to most borrowers. It should seem fair that second lien holders should also consider taking some responsibility for doing the same. They should have the same motivation since they want to keep the borrower in the home, as they will likely lose their entire amount if a default occurs. Also since they earned much higher interest rates from day one, and they in some cases contributed to creating higher borrower defaults, by reducing the borrower's equity in their property, and increasing their total cost of their monthly housing payments.

The reasoning behind having the GSE's not take over the risk of privately held second liens was intended to protect the American taxpayers from further losses. Your perspectives are very appreciated, as these issues are complex and interwoven, and it takes people raising their hands, asking questions, and providing ideas for improvement to create an end result that is fair and accomplishes the right objectives, which is to keep people from losing their homes and help create a recovery in the housing market.


So there you have it. If you--or anyone you know who is under water--wonder why Fannie Mae and Freddie Mac won't pay off a second through a HARP loan, you can quote from the horse's mouth.
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