Underwater borrowers – Fannie Mae mortgages

Borrowers of all kinds continue to be up to their necks, or worse, on their mortgages – a problem that isn’t going away. So, it’s worth coming to terms with borrowers’ options, which vary depending on the type of loan a borrower has. Last week I kicked off the topic with Federal Housing Administration (FHA) loans – the ones supervised by the Department of Housing and Urban Development (HUD).

This week, we’ll branch out from an official Federal government program (FHA) and tackle a semi-official program run by the Federal National Mortgage Association (FNMA), commonly referred to as Fannie Mae. I say “semi-official” because Fannie is a government-sponsored enterprise (GSE) instead of being an actual Federal agency, although thanks to Fannie’s bailout by the Feds, Fannie has become a Federal agency for all practical purposes.

Fannie’s younger brother (it was created later), the Federal Home Loan Mortgage Corporation (FHLMC), commonly called Freddie Mac, is also a GSE and a bailed-out, semi-official Federal agency. But Freddie will have its day next week.

For now, let’s talk about Fannie.

If you read last week’s segment, you know that because HUD runs FHA, HUD also makes the rules. Same goes with Fannie. Because Fannie buys loans from lenders, Fannie dictates how the loans are set up and – critically in today’s perilous economic climate – how troubled loans are restructured or unwound.

Fannie has three ways of helping underwater borrowers avoid foreclosure: refinances, modifications, and short sales. Refinances and modifications are designed to keep borrowers in their homes. Short sales are not. Let’s go over each in turn.

Some borrowers haven’t been hit especially hard by the economic meltdown but are suffering because of the kind of loan they have. For example, if borrowers have an adjustable or variable rate and their interest rate has gone up, their payment may now be so high they can’t handle it. Refinancing to a fixed rate may solve the problem. But for borrowers who have taken pay cuts, a refinance won’t necessarily work. Why? Because refi borrowers – like all borrowers these days – have to qualify for the refinanced loan. Borrowers with drastic pay cuts will be out of luck. But whether borrowers qualify or not depends on the Home Affordable Refinance Program (HARP), a Federal plan encouraging lenders to rework mortgage loans for qualified borrowers.

Before going on, a word here about how the secondary mortgage market works, because the first question most borrowers ask is: “Okay, I don’t make payments anymore to the lender where I got the loan, so who do I talk to?” Answer: the servicer. Who’s the servicer? The firm the borrower now makes payments to. Does the servicer own the loan? Probably not. Who does? Most likely, a whole lot of bondholders who have bought shares of a pool of mortgage loans which generate income as borrowers make their monthly payments of principal and interest. These are the infamous mortgage-backed securities (MBS) we’ve heard so much about. Infamous because, when borrowers begin to default on their mortgages – and borrowers have defaulted in spades – the servicers have to kick in the missed payment to the pool. Not a good deal for servicers unless somebody’s going to reimburse them. Which is what Fannie does in Fannie loans. Which, in turn, is why Fannie lost its shirt and needed a Federal bailout. Which is why we taxpayers are footing the bill.

So there it is: an underwater borrower who wants to refi needs to contact his or her servicer.

Same goes for borrowers who want to modify. But what’s the difference between a refi and a modification? In both, borrowers have to qualify to prove they can make the new payment. But the chief difference is that modification borrowers are in deeper water than borrowers seeking to refi. Most have taken hits in pay which means they can’t afford their monthly payment, even if they originally could. But if their loan could be restructured to meet their current income, things would be all right. Usually, that means knocking off some of the principal balance to a level borrowers can afford. But the amount knocked off isn’t forgiven. Instead it becomes a junior note behind the newly reduced loan, and it’s secured by a junior mortgage. In other words, ultimately it will have to be paid off. Problem is, if there’s already a junior lien, such as a home equity mortgage – and usually there is – a modification won’t work.

Which leads to short sales.

Clearly, short sales are less favored by Federal programs designed to keep people in their homes. On the other hand, they’re a practical way for unworkable mortgages to be wound down. In a nutshell, the lender agrees to accept less than is owed when the house is sold to a new owner. How much less depends on Fannie.

To take advantage of a short sale through Fannie, the underwater borrower must have a verifiable loss of income or increase in living expenses and must actually be delinquent on the mortgage loan. In addition, the property must qualify price-wise based on a broker price opinion (BPO) based on “as is” value. Borrowers can’t pay for repairs and, unlike FHA short sales, can’t receive cash at closing. The short sale won’t be approved without a closing date, which seems backwards because a potential buyer won’t want to put out much time, energy, and money unless it’s reasonably sure Fannie will approve. Programs that pre-approve a sale price make more sense.

The good news for brokers is they’re allowed a 6% commission (3% if only one broker). Because lenders tried to chisel down sales agents to receive more money themselves, Fannie cracked down on reducing commissions in its Servicing Guide, Part VII, Section 504.02, effective March 1, 2009. See Fannie’s Announcement 09-03 dated February 24, 2009 (you can Google it).

Also, see Fannie’s Announcement SEL-2010-05 dated April 14, 2010, which tweaked certain procedures. Be sure to Google Fannie and other programs regularly because they change often enough to be a moving target. Fannie’s website is www.efanniemae.com. It’s a good idea to check it frequently to stay up to date.

- Morrie Erickson