Freddie and Fannie's Latest Fix

Struggling homeowners appeared to receive an early holiday present Tuesday in the form of a sweeping loan modification program from Fannie Mae (FNM) and Freddie Mac (FRE). But for some homeowners, that gift may not be generous enough.

The Federal Housing Finance Authority, which took control of the mortgage giants in September, unveiled a rescue program that promises a faster turnaround for renegotiating loans at risk of foreclosure. To be put in place by Dec. 15, the program allows borrowers who've missed at least three months' payments on their Fannie- or Freddie-owned home loan to apply for more affordable payments that cannot exceed more than 38% of their monthly gross household income. Banks administrating Fannie and Freddie mortgages can also lower interest rates to as little as 3%, extend the life of the loan up to 40 years or defer payments on the principal. Citibank (C), Wells Fargo (WFC) and Bank of America (BAC) already agreed to the program's guidelines.

With the government's Hope for Homeowners Act apparently failing to reach struggling homeowners -- in its first month, the program received fewer than 100 applications -- this new deal may seem like the fix everyone has been waiting for. After all, Fannie and Freddie collectively own or guarantee nearly 60% of single-family mortgages nationwide. The problem is most of those mortgages are not the ones in the deepest trouble -- and therefore won't help the neediest homeowners. "This is a step in the right direction, but falls short," said Sheila Bair, chairwoman of the Federal Deposit Insurance Corp. Bair proposed an alternate plan that encompassed securitized loans.

The Fannie-Freddie announcement is just the latest in a string of loan modification programs introduced in recent months. "It's clear that this type of loan modification is what needs to be done," says Peter Tatian, senior research associate for Urban Institute, a nonprofit, nonpartisan public policy research organization in Washington, D.C. "But there's no one lender or one group that's going to be able to fix all of this."

In August, the FDIC put forth a similar modification program for loans owned by now-defunct IndyMac. JPMorgan Chase (JPM) expanded its program -- which has modified 250,000 loans since 2007 -- to rework an estimated 400,000 more. Bank of America said it would begin modifying some 400,000 loans that it inherited in its recent acquisition of troubled Countrywide Financial Corporation next month, as part of an $8.4 billion legal settlement it reached with 11 states in October. And on Monday, Citigroup announced it was halting foreclosures for struggling borrowers who live in their homes as a primary residence and whose incomes are able to cover lower mortgage payments (those who've lost their jobs, for example, may not be able to qualify due to loss of income). Citi also plans to contact 500,000 more borrowers who are on the verge of falling behind in their payments.

Meanwhile, the FHFA is urging other industry players -- which it says represent 80% of troubled loans -- to sign onto its new program. It's too early to determine whether other lenders will follow suit, but it's encouraging that many of the major mortgage lenders are developing loan modification programs of their own rather than abandoning troubled homeowners altogether, says Gail Hillebrand, a senior attorney at Consumers Union, the nonprofit publisher of Consumer Reports.

Despite these promising programs, the housing market faces a long road to recovery. Here's what homeowners (and want-to-be homeowners) should expect in the months ahead:

Bank initiatives thus far, including the new Fannie and Freddie program, focus solely on the loans the financial institutions own. Problem is, many mortgages are securitized, meaning they were bundled with other loans and divided into shares for sale to multiple investors, says Tatian. (Ask your lender who owns your loan and see if they can give you a straightforward answer.)

Securitized loans account for roughly two-thirds of single-family mortgages, so until those investor groups are on board with a loan modification program, or the government calls for an industrywide moratorium on foreclosures, there are still plenty of homeowners who will be left without help.

It's unclear just how many homeowners in bank-owned loans will qualify for a loan modification, says Hillebrand. Most programs require applicants to demonstrate hardship, which may not include loans that were barely affordable from the get-go or those with misleading terms. Even in the new, streamlined programs, be prepared to show pay stubs, tax returns and a litany of other financial data.

"Everyone loses in a foreclosure," says Hillebrand. The former homeowner's credit is ruined for future mortgages (and other loans, for that matter), neighborhood home values take a hit and the banks and mortgage investors lose money. "People don't want to buy in a falling market, and lenders don't want to lend." However, as the tide of foreclosures slowly ebbs, home values should start rising, she says.

Modifying thousands of mortgages doesn't come cheap -- and many lenders will take a substantial financial hit. To make up for those losses, it's likely that banks will refrain from lowering rates on newly-issued mortgages.

Despite multiple rate cuts by the Federal Reserve (which typically impacts adjustable rate mortgages, or ARMs) and lower yields on the 10-Year Treasury (a factor that typically determines long-term fixed mortgage rates), mortgage rates have remained relatively stable. A 30-year, fixed rate mortgage averages 6.06%, up from 5.73% in mid-September, reports Bankrate.com. The current average rate on a 5/1 ARM: 5.93%.

The one silver lining for new home buyers: It could be worse. "If all those loans went to foreclosure, that would be a bigger hit for the banks," says Tatian -- and it would translate to even higher rates.