How subprime bailouts would actually work

Lee Christie, a CNN.com staff writer, reports how subprime bailouts would actually work. My summary: those subprime borrowers who can afford it and who have a decent credit score will be allowed to refinance into fixed-rate loans. The article uses Maryland as an example. MD's Department of Housing and Community Development works with approved private lenders. The lenders will administer the new loans. They will bundle up loans and sell them to the DHCD (banks usually do the same, except they sell their loans to government-sponsored agencies or on the open market). Maryland will issue municipal bonds, and use the cash to buy the loans. However, the goal is that the interest from the loans will pay for the interest Maryland is paying on the municipal bonds. If they pull it off, state taxpayers won't be on the hook for additional taxes.

And now, the actual article:
They got themselves into this mess and I don't want my tax dollars used to get them out of it." That's the attitude of many when it comes to bailing out subprime borrowers from bad loans.

Still, many programs to help those facing foreclosure are being launched, with the aim of moving borrowers out of high-interest, variable-rate loans and into lower-rate, fixed ones.

Maryland launched one of the first such plans, called Lifeline, a year ago.

Say you're a homeowner with a 2/28 hybrid ARM due to reset next month from the initial two-year 5.25 percent "teaser rate" to 8.25 percent. It will reset again every six months up to as much as 12 percent.

The difference in monthly payments between the initial rate on your $200,000 mortgage and the first reset is nearly $400 ($1,502 versus $1,104). That's bad enough but after another year or two, your mortgage payment could come to $2,057. You can't afford it.

You can go to one of the approved lenders on the Web site of Maryland's Department of Housing and Community Development and ask to refinance into a fixed rate loan with a permanent low rate. Your payments will not only be lower than the reset rates, they will stay the same the entire length of the loan.

Without Lifeline, many borrowers would not have been able to secure a new loan, at least not with attractive terms. In many cases their credit scores would not qualify them for the rates the state-backed program offers.

In addition, their old lenders may have insisted on enforcing the onerous terms of their original agreements, such as prepayment penalties. The state has more leverage with lenders to compel them to co-operate with the program.

After the approved private lender puts together the new loan, it bundles it with others and sells them to the agency, which uses cash from a bond issue to buy the bundled loans.

The goal is that state coffers would not be used - the state hopes to pay off those bonds with the interest it collects from borrowers. But if too many borrowers default on their loans, it could be hard for the state to break even on the program.

Even if there aren't a lot of defaults, raising money to fund the program isn't free because it diverts resources from other projects, such as construction of bridges or highways. "There's always an opportunity cost for the taxpayer," said Joseph Gyourko, an economics professor with the Samuel Zell and Robert H. Lurie Real Estate Center at The Wharton School.

Not every Maryland borrower is eligible for the program. You can't have household income of more than $126,420 and you can't borrow more than $525,000. These limits vary from county to county, with high-cost areas near Washington, D.C. having the highest maximums.

The loans have interest rates of 6.25 percent for a 40-year fixed and 6.5 percent for a 30-year. There are also interest-only loans available that carry a rate of 6.5 percent. Borrowers pay 2 points at closing for any of these products, which may be folded into the loan.

Maryland also requires that the home be a primary residence and that the loan not exceed 85 percent of the value of the property.

So far, just a handful of borrowers have signed up for the program, fewer than 10 but many more are expected as numerous hybrid ARMs taken out in 2005 and 2006 start to hit their first resets.

To avoid future crises, Maryland is also trying to discourage irresponsible or unscrupulous lending, according to Thomas Perez, secretary for the Maryland Department of Labor, Licensing and Regulation.

"I want to track loan originators who have disproportionate numbers of loans that go into foreclosure," said Perez. Too many dings on a mortgage broker's record, for example, could bring suspension or revocation of the broker's license.

Ohio, which is suffering from a great many job layoffs as manufacturing plants shut down, has a similar program it calls Opportunity Loan.

Mark Wiseman, who runs a foreclosure prevention program for Cuyahoga County (which includes Cleveland), said the state had the highest foreclosure rate in the nation by the end of 2006. There are 1,200 foreclosures a month in his area and forecasts are for 75,000 statewide this year.

On April 2, Ohio announced it would sell $100 million worth of bonds, which could go to $500 million eventually, to fund Opportunity Loan. Rita Parisi, of the Ohio Housing Finance Agency, emphasizes that no taxpayer money is involved in the bailout. "We're selling taxable bonds to make new mortgage loans to homeowners," she says.

As in Maryland's Lifeline program, the bonds are paid off using interest paid by the borrowers.

The subprime mess will be no easy fix
Parisi says her agency works with Fannie Mae to obtain underwriting waivers, approvals for homeowners who are unable to refinance under traditional products, but who qualify for the Opportunity Loans.

Homeowners can go to the agency's Web site for a roster of approved lenders and start the process.

Other states, including Rhode Island, Massachusetts and Virginia, have started or are planning similar programs, according to the National Council of State Housing Agencies. More states are mulling over these and other options, such as interest rate buy down plans and rescue funds.

Nationally, relief for troubled subprime borrowers is coming from Freddie Mac. It has earmarked $20 billion to buy refinanced loans targeting holders of exotic mortgages.

But it will not bailout every borrower. Borrowers must meet tightened credit standards and must be judged to be able to afford the new loan at its highest reset rate. Freddie Mac will limit use of low documented loans, so-called "liar loans," in which borrowers do not have to prove assets or income.

Lenders also must take into account (as they also must do in the state bailout programs) property taxes and insurance in judging the qualifications of an applicant and the agency recommends that taxes be collected in an escrow account.

The program is due to launch mid-summer. Information will come available on the Freddie Mac Web site.