Residential Rescue: Stimulus Help for Homeowners

Recent federal legislation to provide financial relief to current and prospective homeowners through refinancing, mortgage payment modification, changes in bankruptcy law, and tax credits for first-time homebuyers, addresses four critical consumer issues in today’s real estate market: (1) troubled ownership; (2) imminent default; (3) imminent foreclosure; and (4) first-time purchase.This advisory provides a brief overview of the new legislation and related programs, and addresses how consumers can take advantage of them. Some basic examples of specific scenarios are included.Homeowner Affordability and Stability PlanOn Feb. 18, 2009, President Obama announced the Homeowner Affordability and Stability Plan (HASP), which included both refinancing and loan modification initiatives to help homeowners stay in their homes and to help prevent defaults and foreclosures.RefinancingThe refinancing plan will allow some homeowners to convert their mortgages into 15- to 30-year fixed-rate loans with lower monthly payments. Any homeowner now owing 80 percent to 105 percent of the home’s value qualifies. Homeowners must be current on their mortgage payments, which means not more than 30 days late on any payment within the last 12 months. The property must be owner-occupied. About 5 million homeowners will qualify. Fannie Mae has already doubled the number of refinancings since March.Only first mortgages on the borrower’s primary residence where the mortgage is owned by Fannie Mae or Freddie Mac are eligible for refinancing. This option is only available for conforming loans. Other lenders may offer refinancing as well, but the lenders will not receive government incentives to do so.The program begins in April 2009, and ends in June 2010. Before calling your lender, gather your monthly mortgage statement, information about your monthly gross household income, including recent pay stubs, your most recent income tax return, and any second mortgage or home-equity line of credit on the house. Also know the account balances and minimum monthly payments due on all of your credit cards and all your other debts, such as student loans and car loans.Example 1: If the current value of Bobby Borrower’s home were $260,000, he could refinance under the program if he still owed from $208,001 to $273,000.Example 2: Assume Bobby Borrower took a 30-year fixed mortgage for $207,000 with an interest rate of 6.5 percent for a house worth $260,000 at the time. The home value has fallen 15 percent to $221,000 and Borrower still owes $200,000 on the mortgage. Under this plan, Borrower could refinance from 6.5 percent to 5.16 percent, reducing his monthly payments by almost $177, for a savings of $2,122 annually.Mortgage payment modificationThe Home Affordable Modification program, introduced subsequently to HASP, aims to reduce monthly mortgage payments to sustainable levels to avoid default and foreclosure. This program calls for lenders to voluntarily participate in a multifaceted plan directed to first reduce the borrower’s payments to 38 percent of monthly income, and then to 31 percent, through partnership with the government.Approximately 4 million borrowers are eligible for the program. Lenders participating in the program, as of April 16, 2009, are JPMorgan Chase, Wells Fargo, Citigroup, GMAC Mortgage, Saxon Mortgage Services and Select Portfolio Servicing.Borrowers behind on payments or at risk of default are eligible: those suffering serious hardships or major changes in financial condition, such as declines in income, increased expenses, interest rate hikes or high debt-to-income ratios, or those who owe more than their home’s worth. Even borrowers with total debt loads exceeding 55 percent of their income are eligible for modification, but they must first obtain credit counseling. The modified payment plan lasts five years and you only get one chance to modify the loan. Every participant must survive a 90-day trial period, but any pending foreclosure is stayed immediately.Primary mortgage loans of $729,750 or less originated on or before Jan. 1, 2009, may be modified. There is no maximum loan-to-value ratio for modification. You must apply for modification before Dec. 31, 2012.To reach plan goals, first, lenders must reduce monthly payments to 38 percent of monthly income by reducing the interest rate, extending the repayment period, reducing the principal balance, or using a combination of all three methods. Interest rates cannot go below 2 percent. Lenders are not required to reduce principal.Second, to reduce payments to 31 percent of monthly income, the government will match lender reductions dollar-for-dollar to share the difference between payments at 38 percent and those at 31 percent. Further, lenders will receive $1,000 per year to reduce the borrower’s principal by $1,000 annually for up to five years, providing the borrower stays with the program and stays current. All borrowers must fully document income, including a signed IRS 4506-T form and their two most recent pay stubs and tax returns, and sign an affidavit of financial hardship.Finally, if modification does not work and foreclosure is looming, lenders are encouraged to approve short sales or accept deeds-in-lieu of foreclosure. Lenders will receive incentive payments and reimbursements for some expenses. Borrowers could receive up to $1,500 in relocation expenses to make short sales possible.Example: Assume Billy Borrower purchased a home for $260,000 in 2003 with a fully amortizing adjustable-rate mortgage (ARM). The fixed rate of 5 percent lasted for three years and began increasing annually thereafter. It is now about to adjust for a sixth time to 9 percent and become out of reach. For the first three years, monthly payments were $1,395. In year 3, the monthly payment jumped to $1,547. Year 4 to $1,701. Year 5 to $1,858. Year 6 to $2,015. At the end of year 6, Billy Borrower will still owe $234,587—90 percent of the home’s value—if it retained that value.It is more likely the home has lost at least 15 percent of its value, falling to $221,000. Though lucky enough to remain employed in a lucrative position, Billy Borrower’s company has frozen salaries, and Billy’s net monthly income is $4,478. He is ineligible to refinance because he owes 106 percent of the home’s value. Under the modification program, Billy and the lender would work to reduce payments to $1,702, or 38 percent of monthly income. Then, the government would make a portion of the reduced payment, reducing Billy’s share to $1,388, saving Billy $315 per month or $3,780 annually.Helping Families Save Their Homes Act: “Cramdown” in bankruptcyOn March 5, 2009, the U.S. House of Representatives passed the Helping Families Save Their Homes Act of 2009, which would allow bankruptcy judges to modify the outstanding principal balance of a borrower’s primary residence to its current fair-market value (the Cramdown Legislation). The bill faces strong opposition in the Senate, and many are skeptical as to whether it will pass. Many fear that these cramdowns could be costly to lenders, and the cost would eventually be passed on to borrowers in the form of higher fees and rates, stemming the availability of credit.Under current law, the court cannot confirm a bankruptcy plan that revises loan terms or reduces debt secured solely by a first mortgage on a primary residence. The new legislation would allow judges to force a lender in a bankruptcy to accept such modified terms. Additionally, the bill would require bankruptcy judges to consider whether banks preyed upon the borrower. If so, the judge would have discretion to help the borrower within federally approved guidelines, which weigh the borrower’s income against current payments and home value.First-time homebuyer assistanceIn 2009, Congress amended the new homebuyer tax credit, making it a fully refundable tax credit of up to $8,000, available until Dec. 1, 2009. Homebuyers need not repay the credit except in limited circumstances. The credit is for those purchasing a family home. It is not intended for speculators. Resale in less than 36 months triggers the repayment requirement.Here are some of the details most important to you. Of course, there are many more, and you should contact your own tax professional before making a decision: Any individual who has not purchased a home for use as a principal residence within the three prior years qualifies. To claim the full value of the credit, individuals must have a modified adjusted gross income (MAGI) of $75,000 or less ($150,000 for joint filers). The credit is gradually reduced, beginning at incomes of $75,000 and higher, until $95,000 MAGI ($170,000 for joint filers), where it completely disappears. Unmarried joint purchasers may allocate the credit to any buyer who qualifies as a first-time buyer, such as a child jointly purchasing with a parent. Though relatives can buy together, you cannot buy from a relative to qualify. The credit is set at 10 percent of the home’s price, or $8,000, whichever is lower. This credit is offset dollar-for-dollar against your tax liability. If your tax liability is less than $8,000, you will get a refund check for the difference. Homes purchased and transactions closed between Jan. 1, 2009, and Dec. 1, 2009, qualify for the tax credit. The property must be residential, and the homebuyer must live in it as his or her principal residence. Utilizing a down-payment assistance program will no longer disqualify you. If you purchased a home between April 8, 2008, and Dec. 31, 2008, you cannot claim the $8,000 credit, but you may claim a $7,500 credit. Unfortunately, this $7,500 credit is basically an interest-free loan and must be repaid to the government over 15 years. To receive the funds, simply claim the tax credit when you file your 2009 tax return, or file an IRS Form 5405 after your purchase. To receive the benefit, before filing your 2009 tax return, you may adjust your federal income tax withholding to increase your available monthly cash immediately. Keep in mind that miscalculations—or deciding not to purchase—will lead to a greater tax liability at the end of the year.Example 1: You and your spouse jointly earn about $88,000 annually and purchase a home that will be owner-occupied for $260,000. You are eligible to claim the full $8,000 credit. Assume your federal tax liability is $8,795. By claiming the tax credit, your liability is reduced to $795.Example 2: Assume a married couple has a MAGI of $160,000. The phase out begins at $150,000. The couple exceeds the cap by $10,000, which is half of the phase-out range ($170,000 – $150,000 = $20,000), therefore the couple qualifies for half of the credit. To determine the amount of the partial tax credit available, multiply $8,000 by half (or 0.5). The result is $4,000.More information is available at FinancialStability.gov.