• Cognizant 20-20 Insights Fixing the Home Financing Market: HARP 2.0 Analysis, Observations and Comparisons Executive Summary program has had on the housing market. Per initial estimates, HARP 2.0 has the potential to The U.S. housing market has been on a decline add $350 billion to the mortgage originations for the past five years, and the resulting financial market over the next two years, thus providing crisis has engulfed the entire global economy. To refinance relief to about two million borrowers. tackle the vicious circle of falling home prices and foreclosures, the U.S. government launched While HARP 2.0 does not address distressed various programs aimed at reducing mortgage borrowers (who are addressed by other programs) defaults through a reduction of payments and and shadow inventory segments, nevertheless it short sale. While the low interest rate regime and is focused on market shortcomings that previous the correspondingly low mortgage rates make programs were unable to solve. This paper it more conducive for homeowners to refinance addresses the attributes and implementation of their mortgages, steadily declining home values HARP 2.0. have made most borrowers ineligible for such programs. The Home Affordable Refinance Background Program (HARP) 1.0, launched in 2009, did cater The U.S. Housing Market Decline to underwater homeowners, but not to a signifi- The U.S. housing market started off the millennium cant extent (e.g., loan-to-value ratios were limited strongly, buoyed in particular by the low interest to 125%). Additionally, high refinance charges, rate regime set by the U.S. Federal Reserve (the and low lender and insurer participation, reduced Fed) to boost the economy after the bursting of the potential relief HARP 1.0 could offer. the dot-com bubble. New home sales increased In November 2011, a revamped version of HARP, at an annual rate of 6.43% over the period 2000 HARP 2.0, was launched. HARP 2.0 caters to signif- to 2005 (see Appendix, Figure A2). Construction icantly underwater homeowners. It features lower activity followed step, with new for-sale homes refinance charges, greater government support rising at an annual rate of 7.46% during the same for lenders, minimal appraisal and underwriting period (see Appendix, Figure A3). Along with requirements, and a simpler and faster process. low interest rates (and the corresponding low The combination of these HARP 2.0 features, mortgage rates), the housing tax policy (capital low target interest rates, signs of stability in the gains exclusion of $250,000/$500,000 for indi- housing market and other supporting initiatives viduals/couples once in two years on the sale of such as an extension of payroll tax cuts could a home) and deregulation in financial markets turn out to have the biggest impact a government (allowing investment and commercial banks to cognizant 20-20 insights | february 2012 merge, use of adjustable rate mortgages, lower absolute numbers as well as in comparison to the control on interest rates set by banks, etc.) fueled total refinance volume. investments in the real estate and mortgage securitization markets. According to the latest estimates by CoreLogic, there are still about 10.7 million underwater However, the interest rates were kept low for a mortgages and an additional 2.4 million mortgage prolonged time. Low interest rates, high home borrowers have less than 5% equity in their prices, and “flipping” (reselling homes to make homes. Negative/close to negative equity has led a profit) effectively created an almost risk-free to a situation in which HARP 1.0 environment for lenders because risky or is being rendered less effective Negative/close to defaulted loans could be paid back by flipping due to risk avoidance from negative equity has homes. Lenders began financing subprime and mortgage insurers, second lien no-doc (no income verification) mortgages. By holders and originators. These led to a situation 2006, the mortgage rates rose to 6.66% from a risk avoidance aspects include in which HARP 1.0 low of 4.65% in 2003 (see Appendix, Figure A1). second lien holders not agreeing is being rendered This decreased housing demand and increased to re-subordinate behind a new the monthly payments for adjustable rate mortgage, insurers not agreeing less effective due to mortgages. The resulting foreclosures increased to transfer the private mortgage risk avoidance from supply, further lowering housing prices. With insurance (PMI) policies to new mortgage insurers, increasing defaults, the securitization market mortgages and lenders imposing backed by these mortgages collapsed, which led overlays on government eligibil- second lien holders to the financial crisis in 2007. The housing market ity guidelines. and originators. has been in decline ever since. The Federal Housing Finance Agency (FHFA) Government Programs to Stabilize recently launched a revamped version of the the Housing Market HARP program, dubbed HARP 2.0, which widens the net to include refinancing to accommodate To help homeowners avoid foreclosure and meet more insufficient and negative equity borrowers their mortgage obligations, and to stabilize the and thereby hopes to improve refinance volumes. housing market, the U.S. government introduced numerous programs beginning with the Housing HARP 2.0: Program Details and Economic Recovery Act (HERA) of 2008’s and Analysis HOPE for Homeowners. Figure 1 (next page) HARP 2.0 was launched by FHFA on November 15, summarizes these programs along with their 2011 to boost refinance volumes and enable more effectiveness in stemming the decline in the U.S. homeowners, even those who are significantly housing market. underwater (LTV>125%), to benefit from persis- From the summary in Figure 1 it is apparent tently low interest rates. that various government programs have had Key Features limited success in reducing loan defaults and The key features of HARP 2.0 are highlighted foreclosures, and have been unable to address in Figure 3 (see page 5). The key changes in all distressed homeowners. Further, none of the the program are removal of underwater limits, programs evaluated in the chart target severely simplified appraisal and underwriting norms, as distressed borrowers. well as reduced guarantee fees — which will make With the prevailing low interest rates, refinance is more homeowners eligible for refinance under perceived as one of the primary ways of reviving HARP. the housing markets. Figure 2 (see page 4) Guidelines tracks HARP refinance volumes and compares The HARP 2.0 guidelines are detailed in Figure 4 it to the total refinance volumes observed since (see page 6). the program’s inception. The refinance volumes under HARP have been dismal, with only about HARP 2.0 is Beneficial for Borrowers, one-quarter of the initial target of three million Servicers, Lenders and Investors to four million refinances achieved as of October HARP 2.0 fills a crucial gap (targeting severely 2011. After a promising start, HARP refinance underwater borrowers), and has the potential to volumes have been on the decline of late, in benefit borrowers, lenders and investors alike. cognizant 20-20 insights 2 Government Support Programs Program and Salient Features Performance Assessment Duration Premise: Write down of principal balance to 93% of current home value As of February 2009, only The program failed because of and reduction of the mortgage payments thereby. 451 applications had been high fees, high interest rates, the Target segment: Struggling and upside-down borrowers who had received and 25 loans need for a reduction in principal HOPE for mortgage payments worth more than 31% of the gross monthly income, finalized, far short of the on the part of the lender, and and were facing possible foreclosure. expected figure of 400,000. the requirement that the federal Homeowners government receive 50% of Eligibility criteria: July 2008 to any appreciation in value of the • The original mortgage is dated on or before January 1, 2008. house. September • The homeowner did not default on the original loan intentionally. 2011 • The homeowner is not invested in multiple home loans. • All information on the original mortgage is true (including income sources and job details). • The homeowner has not been convicted of fraud. Premise: Reduction in mortgage payments through a combination of As of October 2011, the HAMP was a big disappointment rate reduction, term extension and principal forbearance such that following statistics were because of servicers’ inefficien- debt-to-income ratio (DTI) is reduced to 31%. reported: cies in offering HAMP and the Target segment: Borrowers who are facing financial hardship and are • Trial modification offers re-default by many borrowers Home delinquent or in danger of becoming delinquent. (cumulative): 1.95 million. who were issued HAMP modifica- tions. With the program due Affordable Eligibility criteria: • Active trial modifications: to expire by December 2012, • Owner occupied and mortgage obtained on or before January 1, 2009. Modification 85,060. only 735,464 homeowners are Program • The homeowner has a mortgage payment that is more than 31% of • Permanent modifications currently in permanent modifica- his/her monthly gross (pre-tax) income. (HAMP) started: 883,076. tions and 85,060 are under trial • Up to $729,750 is owed on the home. • Active permanent modifi- modifications. These numbers March 2009 • The homeowner has a financial hardship and is either delinquent or in cations: 735,464. are well short of initial promises to December danger of falling behind. to lower mortgage payments for 2012 • The homeowner has sufficient, documented income to support the 3 million to 4 million borrowers. modified payment. This program too did not offer • Homeowner must not have been convicted within the last 10 years incentives to significantly help of felony larceny, theft, fraud or forgery, money laundering or tax underwater borrowers. evasion, in connection with a mortgage or real estate transaction.