Thursday, December 13, 2007

Mortgage Pain Hits Prudent Borrowers

Some of the costs of cleaning up the nation's mortgage crisis are beginning to hit innocent bystanders: people who pay their bills on time and avoid excessive debt.

Fannie Mae, the giant government-sponsored mortgage investor, last week raised costs for many borrowers by quietly adding a 0.25% up-front charge on all new mortgages that it buys or guarantees. On a $400,000 mortgage, that would mean an extra $1,000 in fees, almost certain to be passed on to the consumer. Freddie Mac, the other big government-sponsored mortgage investor, is expected to impose a similar fee soon, according to a person familiar with the situation.

The new charge from Fannie Mae adds to the general gloom over the housing market. It comes as mortgage interest rates are heading up again after a recent dip -- as well as increases in mortgage-insurance costs, tougher requirements on down payments and other moves by lenders to ration credit. And last month, Fannie and Freddie imposed surcharges for mortgage borrowers with lower credit scores.

Loan applications have been so slow lately, says Lou Barnes, a mortgage banker in Boulder, Colo., that it feels like "our client base today is limited to people who don't read the newspaper or watch television."

Still, mortgage loans remain available for many people at rates that are attractive by historical standards. People with good credit scores and enough savings to pay a substantial down payment can still get 30-year fixed-rate mortgages of as much as $417,000 for 6.14% on average, according to HSH Associates, a financial-publishing firm in Pompton Plains, N.J.

But so-called jumbo loans -- those above $417,000, the ceiling on mortgages that can be bought or guaranteed by Fannie and Freddie -- have become much more expensive in relation to smaller mortgages.

The average rate for a fixed-rate jumbo loan is 7.13%, according to HSH. That is down from a recent high of 7.46% but remains lofty in comparison with "conforming" loans, those that can be sold to Fannie or Freddie. The premium paid for jumbo loans ballooned in August, when many loan investors began shunning mortgages lacking a guarantee from Fannie or Freddie.

Fannie said its new 0.25% fee will apply to loans sold by lenders to Fannie or placed into pools of guaranteed loans backing mortgage securities as of March 1, 2008. Lenders are likely to start adding that fee over the next few weeks because there is often a delay of several months between loan terms being offered to consumers and the sale of a completed loan to Fannie.

In a statement, Fannie said the new fee is needed "to ensure that what we charge aligns with the risk we bear." The National Association of Home Builders labeled the fee "a broad tax on homeownership." More than 40% of all mortgages outstanding are owned or guaranteed by Fannie or Freddie.

The fee is the latest in a series of moves by Fannie and Freddie that raise the cost of credit for some borrowers. Late last month, they imposed surcharges that affect mortgage borrowers who have credit scores below 680, on a standard scale of 300 to 850, and who are borrowing more than 70% of a property's value. For example, someone with a credit score of 650 would pay a surcharge of 1.25% of the loan amount for a mortgage to be sold to Fannie. On a $300,000 loan, that would mean extra fees of $3,750. The fee could be paid in cash or in the form of a higher interest rate than would normally apply.

Fannie also is raising down-payment requirements for loans it purchases or guarantees in places where house prices are falling, which by some measures is most of the country. In these declining markets, lenders will need to cut by five percentage points the maximum percentage of the home's estimated value that can be financed. For instance, for types of loans that Fannie normally would allow to cover up to 100% of the estimated value, the ceiling now is 95% in declining markets.

Standards continue to tighten in other areas. Lenders that make the largest loans and offer the best rates to borrowers seeking jumbo mortgages want borrowers to show not only a good credit score but also enough reserves to cover as much as three years of mortgage payments and carrying costs, says Melissa Cohn, a mortgage broker in New York. Borrowers taking out interest-only loans are being qualified based on their ability to make the full payment once the interest-only period ends and not just the lower initial payment, she says.

Lenders in recent months have sharply scaled back on loans that don't require the borrower to make a down payment or provide proof of income and savings. The bar for credit scores is rising, too. "Historically, lenders would consider top-tier credit [a score of] 680," says David Soleymani, a mortgage broker in Los Angeles. "Now, many of those lenders want to see a 720," but are rewarding such borrowers with better rates, he says.

Mortgage insurers are also raising their prices and tightening their standards. Mortgage insurance is typically required when a borrower finances more than 80% of a home's value. During the peak of the housing boom, many borrowers got around this requirement by taking out a so-called piggyback mortgage, which combined a mortgage with a home-equity loan or line of credit. But demand for mortgage insurance has climbed as most lenders have stopped promoting piggyback loans.

Triad Guaranty Insurance Corp., Winston-Salem, N.C., this month stopped providing mortgage insurance on option adjustable-rate mortgages, which carry low introductory rates but can lead to a rising loan balance. Triad also said it would no longer provide mortgage insurance for loans that exceed 97% of a home's value. It set a 90% threshold for loans in four states where home prices have been dropping fast: Arizona, California, Florida and Nevada. "We want to look for people who have more equity rather than less equity" in their homes, says Triad Vice President Jerry Schwartz.

PMI Group Inc., a Walnut Creek, Calif., mortgage insurer, this fall stopped writing mortgage insurance for borrowers with credit scores below 620 who are financing more than 95% of their home's value. PMI also has boosted prices for most borrowers who have credit scores of 620 and higher with loan-to-value ratios above 95%. Borrowers with credit scores between 620 and 659 who are financing more than 97% of their home's value face the biggest increase. The monthly premium for a $200,000 mortgage will increase by $123 to $283.

Starting next month, MGIC Investment Corp. will no longer insure loans when income and assets aren't fully documented unless borrowers can show they are self-employed and are either buying a home they intend to live in or are refinancing the mortgage on their home without pulling cash out. MGIC also will no longer insure loans in California and Florida where the borrower has less than 5% equity and is raising premiums for certain borrowers. "This is the first significant price change since the mid-1980s," says Michael Zimmerman, MGIC's vice president of investor relations.

With standards tightening, some borrowers who might previously have looked for a subprime mortgage or 100% financing are turning to loans guaranteed by the Federal Housing Administration, which for a fee insures mortgages as much as $362,790. Peter Lansing, a mortgage banker in Denver, says that FHA loans accounted for more than half of his business last month, compared with less than 10% a year ago.

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Homeowners, States Draw Lines In the Sand Over Beach Ownership

SURFSIDE BEACH, Texas -- When Brooks Porter bought two vacation homes on the shore of this seaside village 25 years ago, roughly 200 feet of beach separated the properties from the Gulf of Mexico. Now, the sea laps beneath Mr. Porter's houses and those of his neighbors, sucking away the sand beneath them and gnawing on the now-exposed wooden pilings that support them.

Yet Mr. Porter and his neighbors aren't railing at Mother Nature. Rather, they are angry with the state of Texas, which notified the homeowners in 1999 that, due to the erosion, their houses were in the public right of way on the beach and the state could eventually require the homes' removal or demolition.

In the ensuing months, 14 houses were moved off the beach, and nine others were bought by the village and demolished. Today, only 14 remain on the beach.

Those owners, as well as some who have since relocated, sued the state and the village in 2001 in state court to block the removal of their houses. "They just can't take our land and not compensate us fairly for it," says the 67-year-old Mr. Porter. "It's just wrong in so many aspects."

The Surfside Beach standoff illustrates the challenges of defining the boundary between public and private property on constantly eroding beaches, as well as maintaining public access to those shores. From the beaches of Hawaii and California to those in New Jersey and Florida, regulators and property owners are haggling over how to define the boundary when the water line to which it is pegged continually shifts.

Property owners are battling in some states over so-called building setbacks, which dictate how far new structures must be built from the water. Hawaiian counties, for example, require that new construction be at least 20 feet and often up to 40 feet inland of the shoreline.

In recent years, some landowners planted salt-tolerant plants at their seaward property line, hoping the vegetation line would serve as the shoreline for setback purposes even if the tide sometimes extended past the plants. The state agreed in some cases, but concerned neighbors and environmental groups sued to have the issue clarified. Hawaii's Supreme Court ruled in 2006 that the starting point for setbacks is the highest wash of the waves at high tide, regardless of vegetation.

The biggest fight has been over public access to beaches. States such as Maine and Massachusetts allow landowners to shut off public access to beaches on their property. Others including Florida and New Jersey define state property as anything seaward of the mean high-tide line. A few, notably Texas and Oregon, go further by requiring that the public be allowed access inland to the vegetation line, even if it results in beachgoers rambling onto private land. California regulators recently resolved a years-old legal battle in tony Malibu, where movie producer David Geffen balked at allowing the public to walk along the edge of his property to get to the beach. Under pressure from public-access group Access for All, he eventually agreed to allow anyone to use a pathway adjacent to his beachfront mansion.

In Florida, erosion from storm surges in 1999 and 2004 turned private waterfront property into what Volusia County, home to Daytona Beach, claimed was a public right of way where beach-cruising motorists could drive and park their cars. The county's rationale was that motorists had driven along that section of beach for years, and the movement of the shoreline should not interfere with the custom. Three property owners represented by property-rights law firm Pacific Legal Foundation sued the county, and a state appellate court ruled in their favor last year.

Texas' mandate to allow extensive public access to its shores has its roots in the state's days as a Spanish colony when wagons and horsemen used the beach as a thoroughfare. That free-roaming sentiment was formalized in 1959 in the Texas Open Beaches Act, which identifies as state land anything seaward of the mean high-tide mark and requires unimpeded public access from the water to the shore's vegetation line. So, if a storm surge scours away the grass around a home -- as happened to Mr. Porter and his neighbors during storms in 1998 and 2001 -- the house suddenly is in the public's path and the state can order it removed as a hindrance to public access.

Surfside Beach, a seaside getaway 65 miles south of Houston, counts fewer than 800 year-round residents but hosts thousands of summertime vacationers. Beach erosion is a big problem here. Village officials estimate the Gulf of Mexico has encroached inland by 200 feet since 1980. Neighbors on Beach Drive -- the street that runs along the shoreline -- point to watermarks on their pilings to illustrate that the beach's sand level recently was six feet higher. The beach's plants and grasses, which once extended 50 feet seaward of the houses, have retreated well inland of them.

"It might be your land, and you're able to pay taxes on it," Mayor James Bedward said. "But once it becomes submerged, it's no longer that way. It becomes state land. They're all on a public beach right now."

The Texas General Land Office, which regulates land issues including beach access, notified several Surfside Beach homeowners in 1999 and thereafter that their houses had wound up on the public beach and could face removal. Mr. Porter responded to the state's salvo by rallying his neighbors and hiring Houston attorney Ted Hirtz and the Pacific Legal Foundation to sue.

As the suit slowly proceeded, the homeowners' plight grew more dire. In October 2006, a surge of seawater further ravaged the beach and knocked out water, sewer and electrical services to the Beach Drive houses. Village officials refused to reconnect water and sewer service, explaining that the Open Beaches Act prohibited them from repairing private structures that illegally occupy public property or rights of way. The village also dumped a line of rubble along the seaward shoulder of Beach Drive, protecting the road from erosion by the waves but also blocking Mr. Porter and his neighbors from pulling cars into their driveways.

The beach houses have languished mostly uninhabitable for the past year, their external stairways and carports collapsing as the sea undermines them. Meanwhile, several Beach Drive neighbors took advantage this year of offers from the village and state to move or buy out their properties. The state has granted reimbursement of up to $50,000 each for owners who hoist their house upon a trailer and move it elsewhere. The village landed a $1.2 million federal grant this year that allowed for buyouts.

Most of the owners of the 14 remaining houses on the beach are staunch holdouts. Some say they want the state to save their houses by replenishing the beach. Absent that, they say the village should pay them fair-market value for their houses and their land.

For every solution the homeowners propose, the village and the state raise a counterargument because public money cannot be used to "enhance" private property by dumping sand around the houses. The village has so far refused to condemn the offending houses for fair-market value, noting that their state of disrepair and the pending lawsuit make determining their value difficult.

Both sides anticipate that a state judge soon will formally dismiss the lawsuit. The neighbors plan to appeal and seek an injunction barring removal of their houses as the appeal is heard.

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When Homeowners Find Breaking Up Hard to Do

Question: I bought a house with my ex-fiancé, but unfortunately the relationship dissolved. We both have joint ownership of the home. Should I buy him out and keep the house or give him a lump sum with the condition that he refinance the home in his name? If I keep it, I'm afraid I won't break even in the next few years with this current housing market.

Cary: I bet you thought there were only two of you in your relationship when you bought the house with your ex-fiancé. But in reality, there were three: You, him and your lender.

Unfortunately, you can't completely break up with your ex without calling it quits with the lender, too.

I'm presuming, of course, that both your names aren't just on the title but also on the loan. That means that the lender will hold you both equally responsible for the debt -- and won't be eager to let either of you go unless the person who keeps the house can prove that he or she can keep up loan payments, too.

The cleanest way to break up with the lender is to sell the house. Then you and your ex can split the proceeds according to your respective investment in the property. Given your doubts about the future of your local housing market, this may be the smartest choice.

It may take a long time to sell your house, however, especially given the slowdown of the auto industry in your area. So another option is for both of you to move out, continue to meet your mortgage obligations and rent the place out until the market recovers. (Although most economists are predicting that the overall housing market will improve within the next two or three years, it's anyone's guess when that will happen within particular neighborhoods.)

But if you can't stomach the thought of keeping financial ties with someone with whom you've severed emotional ones, then you must decide which one of you is most able to handle a mortgage payment solo -- because that's all that your lender partner cares about. You and your ex should investigate refinancing together since whoever shoulders the new debt will also have to deal with a new interest rate and closing costs. Any home equity accrued during the time you both lived there will reduce the amount owed. The lump sum that the other person pays should reflect that.

As you split your financial obligations, don't forget to sever your legal ones, too. The partner who is giving up ownership of the home needs to sign a quitclaim deed -- in which that person relinquishes any legal claims to the property -- that must be filed with the county.

Your lender can help you with the technical aspects of the breakup. But only you and your ex can figure out how much post-breakup contact you can stand and whether the potential financial benefits outweigh the emotional costs.

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Mortgage-Relief Legislation Advances In Congress

Several House Judiciary Committee members have agreed on a piece of housing legislation that would give bankruptcy-court judges more flexibility to alter the terms of certain mortgages.

Meanwhile in Ohio, which has one of the nation's highest foreclosure rates, the attorney general has asked state judges to dismiss or delay some foreclosure actions. The proposed dismissals are meant to encourage mortgage companies to renegotiate terms of the loans, to keep borrowers in their homes. At the end of the third quarter, 3.7% of home loans in Ohio were in foreclosure, up from 3.6% in the second quarter, according to a Mortgage Bankers Association survey. The number of new foreclosures in Ohio rose by about 20% in the same period.

While the deal in the House indicates progress, Rep. Brad Miller (D. N.C.), an architect of the bill, said the full House of Representatives won't vote on it until next year. So, Congress will probably recess this year without passing one major bill targeting the housing crisis.

Also in the works, but gummed up in the Senate, is a bill that would let the Housing and Urban Development Department's Federal Housing Administration help more struggling borrowers, and another bill that would change the ways mortgages are sold and securitized.

Those moves by Congress would be in addition to a much broader mortgage plan recently announced by the industry and the Treasury Department, which would help some struggling homeowners either refinance or win a temporary freeze on their low, introductory interest rates.

The bankruptcy issue before the House, which was opposed by the mortgage and financial-services industries, has been perhaps the most sensitive public policy proposal to date aimed at helping borrowers struggling with their mortgages. Republicans and the banking industry delayed the matter, arguing that it could raise interest rates for all homeowners and rattle the market for securities backed by these loans.

Late last week, Democrats agreed to make significant changes to the bill and won the support of Rep. Steve Chabot (R. Ohio). The panel plans to vote today, then the measure would be sent to the House floor. The chances of the bill's passing in the Senate are uncertain.

Under the agreement, this bankruptcy-law change would expire seven years after the bill is enacted, and would give bankruptcy judges only the authority to alter the terms of subprime and nontraditional mortgage products originated between 2000 and 2007. Earlier proposals didn't specify which mortgages could be altered.

In Ohio, dismissal motions have been filed by Attorney General Marc Dann in 31 foreclosure cases in five counties since last month, and more will be filed soon, a spokeswoman for Mr. Dann said. The motions argue that the plaintiffs, often banks that act as trustees for investors of securities backed by mortgages in the cases, don't actually hold the promissory note and mortgage, and so don't have a right to foreclose. The situation occurs in part because mortgage documents and the contracts between borrowers and lenders may change hands multiple times and may not be assigned to the plaintiffs at the time the suits are filed.

Whether those circumstances should lead to dismissal of cases is being debated across the country. In Ohio, judges haven't yet ruled on Mr. Dann's motions.

Mr. Dann's move follows a series of court rulings in Ohio this year in which several federal judges dismissed dozens of suits on similar grounds. In October, federal Judge Christopher A. Boyko in Cleveland dismissed 14 foreclosure suits filed by Deutsche Bank National Trust Co., writing that "the institutions seem to adopt the attitude that since they have been doing this for so long, unchallenged, this practice equates with legal compliance." Deutsche Bank declined to comment on the ruling.

State attorneys general have been responding in different ways to the wave of foreclosure actions that has come in the wake of rising defaults on subprime mortgages. Earlier this year, Mr. Dann sued several mortgage lenders and brokers, alleging that they violated state consumer-protection laws by pressuring appraisers to inflate home values. He asked that the companies pay $25,000 in civil penalties in each case. So far, the state has gotten a default judgment against one broker and has settled with two brokers, according to Mr. Dann's spokeswoman.

In New York, Attorney General Andrew Cuomo filed a lawsuit in November against a home-appraisal firm, alleging it had defrauded consumers by allowing its biggest customer, a national bank, to exert pressure for higher property valuations to help ensure that loans went through. Mr. Cuomo has subpoenaed participants in the secondary market for mortgage debt, including investment banks that sell mortgage-backed securities.

Lately, some Ohio state judges have ruled against banks for filing suits without showing proof that they hold the mortgage. Mr. Dann's motions urge judges to review foreclosure filings in their courts and, as warranted, dismiss actions on the same grounds. Short of that, he encourages judges to order mediation so that "parties can negotiate a workout agreement, thereby resolving their dispute without resort to foreclosure.

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Why Borrowers May Not Benefit From Rate Cut

Not all borrowers are benefiting from the Fed's moves to cut interest rates. The problem: Loans that are tied to a variety of interest-rate benchmarks -- some of which aren't necessarily moving in lockstep with Fed action.

Yesterday, the Federal Reserve cut short-term interest rates by a quarter of a percentage point to 4.25% -- the central bank's third rate cut since mid-September -- to help ease the credit crunch and reduce the economy's chances of falling into a recession. The moves have helped some borrowers who have seen interest rates on their credit cards and home-equity lines of credit fall. Interest rates on many fixed-rate mortgages also have dropped amid a decline in Treasury yields as investors sought out safe investments.

But rates remain stubbornly high on other loans, including student debt and many adjustable-rate loans made to the same type of subprime borrowers whose troubles are now reverberating throughout the global financial system. These rates remain high because many of these loans are tied to the London interbank offered rate, or Libor, and not to more conventional interest-rate benchmarks such as Treasurys or banks' prime rate.

Libor, which is an interest rate banks charge on loans to each other, normally tracks the federal-funds rate closely. But continuing worries over the credit crisis have kept Libor unusually high -- partly because banks are reluctant to lend to one another -- even as other short-term interest rates have fallen in recent months. The U.S. dollar three-month Libor yesterday was 5.11%, down from 5.36% in late June. Over the same period, three-month Treasury bill yields have fallen much more steeply, to 2.95% from 4.8%. "The Libor spread is screaming that there is a big, big stress point in the banking system," says James Bianco, president of Bianco Research LLC, a market-research firm in Chicago.

Borrowers may need to read the fine print of their loan agreement or contact their lender to know what benchmark their loan is tied to. The biggest impact is likely to be felt among borrowers with ARMs that are about to reset. "If you have a Libor-indexed ARM and you're facing a reset, that's going to be very disadvantageous because of the divergence between the Libor and Treasury yields," says Greg McBride, a senior financial analyst at Bankrate.com.

For example, consumers with an ARM whose annual reset rate is linked to one-year Libor are likely to see their interest rate jump to 6.75% or more. By contrast, a similar loan that's linked to one-year Treasurys is likely to reset to a rate that's about 5.75%, he says.

Libor is frequently used to set rates for ARMs made to subprime borrowers -- mainly people with scuffed credit -- as well as many ARMs that fall into the "jumbo loan" category, which currently refers to most mortgages for $417,000 or more, says Keith Gumbinger, vice president of mortgage-tracker HSH Associates. Also, roughly half of non-subprime ARMs that were originated in recent years are tied to Libor, he estimates.

The higher Libor rates complicate the Fed's efforts to assist troubled borrowers and prevent problems related to the housing crisis from spreading further through the economy.

"The more problems we have in the subprime-mortgage market, the more the likelihood of defaults and foreclosures," says Ray Stone of Stone & McCarthy Research Associates. The federal government has outlined a "rate freeze" program that calls on mortgage servicers to modify certain subprime-mortgage loans to avoid foreclosure.

A recent report from the Federal Reserve Bank of New York shows that the six-month Libor rate will determine the reset rates for an estimated 99% of subprime ARMs and 38% of Alt-A ARMs in the U.S. that have been securitized. A further 1% of subprime ARMs and 22% of Alt-A ARMs will reset based on the one-year Libor rate. Alt-A is a category between prime and subprime that often involves borrowers who don't fully document their income or assets.

In recent years, lenders began pegging a greater percentage of loans to Libor as more of this debt was securitized and sold to investors around the world, analysts say. Since Libor is a global interest-rate benchmark, investors have an easier time hedging their interest-rate risk because their investments are pegged to a common index, says Bankrate.com's Mr. McBride.

Another factor: Since the U.S. Treasury Department stopped selling one-year Treasurys in 2001, more lenders started tying their hybrid adjustable-rate mortgages to Libor because they believed the Libor index more accurately reflected their funding costs over time than other benchmarks, says Lou Barnes, partner at Boulder West Financial Services, a Colorado mortgage bank.

Other Libor-based loans include certain types of student loans. About half of student lenders peg their private, variable-rate student loans to Libor. The best rates on private student loans are typically prime minus one percentage point or Libor plus 1.8 percentage point, says Mark Kantrowitz, publisher of FinAid.org, a financial-aid Web site. Normally, those rates are very similar, but right now, Libor-based rates are a little bit higher, he says.

That doesn't mean borrowers with Libor-linked loans should jump to other types of loans. Private student loans pegged to Libor, for example, have historically tended to charge a slightly lower rate than loans tied to prime over the life of the loan, says Mr. Kantrowitz.

Homeowners, on the other hand, may be better off in Treasury-linked ARMs over Libor-linked products, if both are available on comparable mortgages. Historically, in times of credit crisis, Libor rates have tended to spike, says Mr. Barnes, the mortgage banker. But Treasury yields at such times often are driven down by investors seeking safe investments, he says.

One bright spot for savers: Higher Libor rates have helped sustain healthy returns in money-market mutual funds. These funds' holdings of Libor-linked debt have helped to offset declining yields on other investments. An estimated 20% to 25% of money-market assets are in floating-rate debt, much of which is linked to Libor, says Peter Crane of Crane Data LLC. That has helped to keep average yields on money-market mutual funds, currently about 4.57%, about a quarter of a percentage point higher than they would normally be in the current interest-rate environment.

The Fed rate cuts have helped borrowers of some other types of loans, especially those tied to banks' prime rate. Average rates on home-equity lines of credit have dropped to 7.60% from 8.25% in early September, while variable-rate credit cards are now charging 13.46% on average, down from 13.97%, according to Bankrate.com.

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