Fed Study Points to Wisdom of Further HARP Enhancements

Economists have been debating the
value versus risk of expanded refinancing opportunities since the early days of
the housing crisis. Proponents argue that refinancing would free up homeowner
money for spending elsewhere to the benefit of the economy, opponents fear that
since the Federal Housing Administration and the government sponsored
enterprises (GSEs) are realistically the only source of refinancing currently
available, any risk inherent in refinancing will disproportionately fall the

To clarify an issue that is of interest to
homeowners, policy makers, and taxpayers, the Federal Reserve Bank of New York
has just published a report, Payment Changes and Default Risk:  The Impact of Refinancing on Expected Credit
Losses by staff members Joshua
Abel, Joseph Tracy, and Joshua Wright
that looked at whether refinancing lowers the risk of default.

Earlier studies have looked at defaults after loan modifications which reduce
rates and/or payments.  One study found
that for a sample of modifications to securitized subprime mortgages a 10
percent reduction in the monthly payment was associated with a 4.5 percentage
point reduction in the 12-month redefault rate.

Extrapolating earlier studies to
suggest that expanding the government’s Home Affordable Refinance Program might
result in lower defaults is suspect because the one study mentioned concerned
only subprime borrowers while HARP involves prime borrowers with much stronger
initial credit profiles and those borrowers who were given modifications were
already seriously delinquent while HARP requires homeowners to be current with
a relatively clean payment history over the previous 12 months.    

ideal study would link together the prior mortgage with the HARP-refinanced
mortgage so that one could measure the percent reduction in the monthly payment
and estimate how HARP impacts the likelihood that the borrower will default on
the refinanced mortgage. With such a linked HARP mortgage data set, one could
control for other important factors, such as the borrower’s updated
loan-to-value (LTV) ratio, when estimating the impact of the payment change on
the default risk. However, no such linked data set on HARP-refinanced mortgages
exists, making it difficult to estimate the effect of lower monthly payments on
the population of HARP-eligible borrowers.

The New York Fed study approached the issue by studying the impact of
refinancing adjustable rate mortgages (ARMs)

While these are significantly less common than fixed rate mortgages,
this methodology provided some advantages for estimating the impact of
refinancing on fixed-rate borrowers such as allowing the researchers to compare
similar borrowers in terms of their credit profiles when their mortgages were
originated.  As rates have dropped, the
rate resets on many ARMS resulted in lower monthly mortgages payments, mimicking
refinances, and the percentage reduction in the mortgage payment from
origination date to the most recent reset date can be used to help explain
subsequent default behavior by the borrower. 
approach also addresses the issue of pre-existing delinquency raised by using
mortgage modifications in a study.

The authors used a sample of over
173,000 prime ARMS originated since 2003 and on which there were an aggregate
of 6.5 million monthly payments and controlled for a number of factors that
might affect a default rate such as the original FICO score, the updated LTV ratio,
employment data, and home price changes.

on borrowers with an updated LTV of 80 or higher who would be candidates for
refinancing under the HARP program, the authors found that a 26 percent
reduction in the monthly mortgage payment, which they estimated would be the
average reduction through a HARP refinancing, would result in a 3.8 percentage
point reduction in the five-year cumulative default rate. Combining this with
an estimate of the likely losses given a default on these mortgages, the results
indicate that borrowers who refinance under HARP have an estimated reduction in
projected credit losses of 134 basis points, or for every billion dollars in
agency mortgage balances that refinance through an improved HARP, the estimated
reduction in credit losses would be $134 million. This reduction would
primarily benefit taxpayers, although private insurers of the underlying
mortgages would also receive some benefit.

The authors note that enhancements such as removing
the previous 125 percent LTV ceiling were made to HARP last October and further
enhancements are being debated.  They
argue that improving HARP will provide benefits to the economy by increasing
the disposable income to households that refinance and saving taxpayers money
by reducing credit losses by Fannie Mae and Freddie Mac.

Article source: http://www.mortgagenewsdaily.com/09252012_refinancing_benefits.asp

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