States Offer Aid for Homeowners, but Help Few

The premise of this plan is fairly simple: Just as states can issue tax-exempt bonds to finance programs for first-time home-buyer assistance, the government is asking that Congress temporarily allow states to issue tax-exempt bonds to fund programs that would help homeowners refinance their mortgages. Such programs could offer a much-needed break for homeowners facing unaffordable mortgage rate hikes, as the new loans will carry lower rates and will generally be fixed for 30 or 40 years.

The problem is, eight states — including New York, Massachusetts and, most recently, California — already run similar programs and so far, they've seen lackluster results. In fact, they've been able to provide little, if any, help to the homeowners who need it the most, namely those who are already delinquent on their loans or those who, thanks to falling housing prices, now carry mortgages bigger than their homes are worth.

Also, despite strong interest from homeowners, these programs have only been able to help a handful. In Maryland, which launched its program back in June 2006, only 28 loans have been refinanced or are in the process of being refinanced, despite more than 5,000 inquiries from homeowners. Massachusetts has received about 3,500 calls, but is in the process of refinancing only eight loans. Pennsylvania has closed eight loans out of 1,500 applications. And in New York, where 75 to 150 calls are received daily about the refinancing program, only one loan has refinanced and two are going through the pipeline.

One of the biggest issues is that these programs are too restrictive. "Most of the calls we get at this point are from people who are severely delinquent, and [those people] we are unfortunately unable to help," says George Leocata, senior vice president of New York's Single Family Programs. Due to its program's slow uptake, New York is announcing plans Thursday to relax its requirements, including dropping the minimum credit score below 600.

Still, because the program can only do 100% financing — meaning it can guarantee a mortgage up to 100% of the home's value at the time of refinancing — it leaves out homeowners who owe more on their homes than the homes are worth, or, in industry-speak, are "upside down" on their loans. "Unless the borrower has the cash to make up the difference, we can't help them," Leocata says. This is the case with all other state programs, which top so-called loan-to-value ratios at 105% at most. (The additional 5% goes to cover closing costs or other fees, such as prepayment penalties.)

Another hurdle is the states' need to appeal to investors. Details vary by state, but financing for these programs is provided much the same way the majority of subprime loans were financed by lenders in the first place: States provide the initial financing, but then the loans are re-packaged into mortgage-backed securities and sold off to investors. By creating relatively strict underwriting standards — minimum FICO score requirements, loans that are no more than 60 days delinquent, loans that cover no more than 100% of the current value of the home — the states are simply making sure that they have buyers for these securities and can continue running such programs.

In Maryland, efforts to extend the state's refinancing program to delinquent or upside-down borrowers have been shut down by potential investors. "We've been warned that the rating agencies would not look favorably toward rating a product that has those types of mortgages in them," says Bill Ariano, deputy director of the Community Development Administration at the state's housing department. "More importantly, the bond market itself is at this point showing indication that they wouldn't be interested in purchasing them. And if you think about it, that's one of the reasons the market is in such trouble in the first place — investors are running for the hills."

Dino Mallas, a vice president at T. Rowe Price and manager of its California, New Jersey and New York tax-exempt bond funds, echoes Ariano's concerns. While his funds currently own debt issued by state housing authorities, he says he'd be asking tough questions if these states reduced their credit standards for qualified borrowers. "Does it concern me? If they were to lower their standards, then of course it would," he says. (In addition to relying on ratings from agencies like Fitch Ratings and Moody's, T. Rowe Price rates all securities internally.)

The tepid results have kept some states from starting programs of their own. The Wisconsin Housing and Economic Development Authority, for example, is instead focused on pulling local lenders, realtors and credit counselors together to support the 1-888-995-HOPE hotline, which counsels individual homeowners based on their specific issues.

Since the states aren't allowed to issue tax-exempt bonds for loan refinancing, they finance these programs by issuing taxable bonds or, in some cases, using agency reserves. The states have an incentive to extend their refinancing programs to as many homeowners as possible because the cost to issue bonds is fixed no matter how many are issued. However, this also deters them from implementing bond-funded programs that are too small in size. In Ohio, for example, so far $4.5 million in mortgage refinances has been funded out of the agency's own coffers. Bob Connell, director of debt management at the Ohio Housing Finance Agency, estimates that it would be "cost prohibitive" to start issuing taxable bonds unless the amount to be funded reaches $15 million to $20 million.

And while the government's plan to enable states to issue tax-exempt bonds would certainly help — these are more attractive to investors since they offer higher after-tax returns, and at the same time will enable the states to offer loans to homeowners at even lower rates — critics say the plan might take too long to execute.

"This is a national catastrophe that requires national action," says John Taylor, president of the National Community Reinvestment Coalition, a consumer group. "Waiting for 50 different state governments to try and create the mechanisms is simply a laborious, slow process." His suggestion: Create a federal program with consistent underwriting standards and application requirements that reaches "every corner of the United States."