Congress' plan to allow people to refinance into more affordable mortgages won't just relieve thousands of homeowners – it's also expected to save the banks who issued the loans billions of dollars.
Most banks will end up losing much less money handing mortgages over to the government than they would if the loans defaulted and the homes went into foreclosure. Plus, it will be up to the bank to decide whether to allow the homeowner to refinance.
“The banks should be thrilled with this,” said John Vogel, professor of real estate at Dartmouth College's Tuck School of Business. “The banks have been pushing it. This is as good a deal as they were going to get.”
The legislation, which the House approved during a rare Saturday session and which President Bush is expected to sign into law, is expected to affect at least 400,000 homeowners. It comes after several months of discussions between lawmakers and lenders. Banks including Credit Suisse and Charlotte's Bank of America submitted proposals.
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Banks and other mortgage holders will likely save some $16 billion if they let homeowners refinance into mortgages issued by the Federal Housing Administration, said Ladenburg Thalmann analyst Richard Bove. That's assuming that banks will lose roughly $25,000 per homeowner by selling their mortgages to the FHA, and that they would eventually lose about $64,000 per homeowner, on average, by allowing homes to foreclose.
“I don't think it helps the banks in the near term, but I think it's an enormous boost in the long term,” Bove said.
The government's decision to set aside $4 billion for communities slammed by foreclosures should also help to stabilize tumbling home prices, experts say.
The plans, however, are not seen as a panacea for the housing and financial-market crises. First, if banks and mortgage servicers decide they don't want to allow their borrowers to get FHA loans, they don't have to.
The reason behind this rule is that it allows banks to be more flexible, said Bob Davis, executive vice president at the American Bankers Association, which advised Congress on aspects of the legislation. If a bank wants to keep its customers, it can let them refinance within the bank as an alternative to turning the mortgages over to the FHA.
But the rule could also mean that banks, hoping to avoid immediate losses, won't offer relief to as many homeowners as the government intends, according to Tuck's Vogel. He said the 400,000 figure “might be optimistic.” And if homeowners don't think their banks will allow them to refinance into FHA loans, they might still decide to send in their keys and walk away from their loans, Vogel said.
Another point of contention is the idea that American taxpayers are paying for the risks other people took. In the current legislation, there is little specificity about “bailing out institutions because of where they were located and what markets they were hit by, rather than those that took big risks,” said Brad Neigel, a senior analyst at the financial services research firm Aite Group.
Meanwhile, it is unlikely that permitting struggling homeowners to refinance their mortgages will stanch the growing number of bank failures. Since the credit crisis began last summer when mortgage defaults began spiking, nine banks have been seized by the Federal Deposit Insurance Corp., including IndyMac Bancorp.
Institutions that are sitting on enough capital should be able to take the initial hits from selling off their mortgages at a loss and eventually come out ahead, Neigel said. But, he added, “the ones that are really struggling, that are really undercapitalized, will fail. They're not going to be able to take losses.”
And there's no guarantee that a refinanced loan will not eventually become a foreclosure for the FHA, Neigel said. “You wonder, are we just putting a Band-Aid on a bigger problem that isn't being addressed?”
It is unclear at this point the extent to which banks and investors who issued and bought risky mortgages will offer the FHA refinancing option. The American Bankers Association's Davis said he expects the majority of the loans sold to the FHA to come from securitized pools of resold and repackaged mortgages.
Citigroup Inc., for one, said it expects to participate in the refinance program, but that “once the final regulations are available from the agencies, we will be better positioned to evaluate the scope of our participation,” a Citigroup spokesman said in a statement.