Underwater borrowers – Freddie Mac mortgages

For the past two weeks, I’ve been going over Federal programs designed to help borrowers drowning on their mortgages. Two weeks ago I kicked off the topic with Federal Housing Administration (FHA) loans, which are supervised by the Department of Housing and Urban Development (HUD) – an actual Federal agency.

Last week we went over what I call a semi-official program run by the Federal National Mortgage Association (FNMA), dubbed Fannie Mae. Fannie was established in 1938 after the collapse of the housing market in the wake of the Great Depression (sound familiar?). You’ll recall that Fannie is “semi-official” because it’s a government-sponsored enterprise (GSE) instead of being an actual Federal agency, although because Fannie was bailed out by the Feds, it might as well be a Federal agency.

Fannie’s younger brother, the Federal Home Loan Mortgage Corporation (FHLMC), which was created in 1970 and is commonly called Freddie Mac, is also a GSE and a bailed-out, semi-official Federal agency.

Sometime in the next couple of years, Congress will have to decide what to do about Fannie and Freddie. Should the Federal government take them over and turn them into Federal agencies? Should they be privatized and run like large corporations? Or should they continue as GSEs with the implied promise of being rescued by the Federal government if they fall on hard times? Tough alternatives with far-reaching implications for the Federal government, taxpayers, and – especially – homeowners.

But those alternatives are for another day. Right now, let’s deal with Freddie.

As I’ve said before, when you talk about loan programs – whether or not you’re mentioning helping underwater borrowers in the same breath – each type of program is lender- or program-specific. In other words, because HUD runs FHA, HUD decides how FHA borrowers are helped. Same goes with Fannie and Freddie. Because Fannie and Freddie buy loans from lenders, each dictates how their respective loans are set up and – critically in today’s perilous economic climate – how their troubled loans are restructured or unwound.

Like Fannie, Freddie has three ways of helping borrowers: refinances, modifications, and short sales. As is pretty obvious, refinances and modifications are designed to keep borrowers in their homes. On the other hand, short sales allow borrowers to unload their property for less than what’s owed – a way of letting over-stretched borrowers off the hook and get on with their lives. Let’s talk about all three.

For borrowers suffering because of the kind of loan they have instead of because of the economic meltdown, Freddie has two options: refinancing through the Same Servicer program or the Open Access program. Both are explained on Freddie’s website: www.freddiemac.com. The concept is that if a borrower has an adjustable or variable interest rate that’s gone up, the payment may now be too high to handle. Refinancing to a fixed rate may solve the problem.

Freddie’s Same Servicer program has an expedited procedure for qualifying if the borrower refinances through the servicer the borrower is currently making payments to. On the other hand, Freddie’s Open Access method allows refinancing through any Freddie-approved servicer, but the qualification process is more involved. Of course, for borrowers who have taken pay cuts, a refinance won’t work if borrowers can’t afford even the revised payments. Keep in mind that the full balance of the loan is still owed; only the loan terms are changed. Ultimately, 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. The key word here is “qualified”.

Modifications work differently, although as with refis, borrowers have to prove they can make the new payment through a 3-month trial period. Usually though, modification borrowers are in more dire financial straits than borrowers seeking to refi. Borrowers’ pay cuts are the prime culprit. So if a loan can be restructured to take into account current income, things might be all right. Suppose a borrower could afford the loan if the principal balance were $30,000 less. A modification will lower the loan to the adjusted balance. Sounds good, but what happens to the $30,000? Usually, the borrower has to sign a new promise to pay it back (maybe interest-free for a few years) and it’s treated like a second mortgage. In other words, it will have to be paid off eventually. But as I mentioned last week in Fannie modifications, if there’s already a junior lien, such as a home equity mortgage, a modification won’t work unless the home equity mortgage moves into third position (behind the lowered first and the new $30,000 second).

So now we’re down to short sales.

To work out a short sale through Freddie, the underwater borrower must be unable to pay the loan long-term, must be in default or nearly so, and must have tried to sell the home “as is” for at least 90 days. Proving the attempt to sell requires pricing the house based on an “as is” broker price opinion (BPO), “broker” meaning a licensed real estate agent.

As with Fannie loans, Freddie borrowers can’t pay for repairs and can’t receive cash at closing. (In contrast, you’ll recall that FHA lets borrowers receive up to $1,000 at closing.) The short sale won’t be approved until Freddie approves the offer to purchase and a closing date has been set.

As pointed out last week with Fannie short sales, this process seems backwards. If I’m a potential buyer with a rate-lock and move-in date on my mind, I won’t want to waste time and energy hoping some far-off servicer will approve my deal. In fact, in our office we’ve found the approval process painfully slow (months!) and convoluted (“You talked to who before and were told what?”) for Fannie and Freddie. Not that it matters to underwater borrowers, potential buyers, and real estate agents, but the delays are largely because the short sale process has been dumped by Congress on servicers who are under-staffed and ill-equipped to handle the crush of business. Suffice it to say that programs that pre-approve a sale price make more sense.

As with Fannie, Freddie short sale brokers are allowed a 6% commission (3% if only one broker).

In all short sale transactions, though, beware of unauthorized flips. A flip occurs when a third party or so-called facilitator acquires the home being sold at a discount (with the seller-borrower’s lender taking the hit) then turns around and sells the home for a profit (which otherwise would have gone to the lender being shorted). If that situation presents itself, the parties must disclose all terms of the transaction(s). Over the first weekend in May, 2010, Freddie came out with guidelines for disclosures, making it clear that Freddie must be told all the facts surrounding the transaction so Freddie isn’t mislead. What the guidelines are saying is: would Freddie make the same decision if it knew all the facts instead of just some of them? Those who don’t fully disclose can expect to land in legal hot water, thanks to Freddie’s short sale fraud task force.

Regardless of whether borrowers are refinancing, modifying, or selling short, they need to know whether any shortfall is being forgiven or simply deferred. As with all other serious matters, especially in real estate, the key is to get it in writing.

Be sure to Google Freddie and other program providers regularly because programs are frequently tweaked. Once again, Freddie’s website is www.freddiemac.com. Plan to check it regularly to stay up to date.

- Morrie Erickson