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Robert Nusgart: Are we facing another doomsday clock?

In his State of the Union address, President Obama again asked Congress to consider legislation that will allow more homeowners to refinance mortgages that are currently higher than the value of their homes.

Millions of homeowners whose mortgages are held or guaranteed by Fannie Mae or Freddie Mac have been able to take advantage of the Home Affordable Refinance Program. HARP allows these homeowners to refinance at today’s low rates regardless of the value of their homes. However, many banks ignore that aspect and put in overlays that limit the value to perhaps 105 to 125 percent of the home’s value. Just another roadblock.

Even though there are signs that the housing industry’s heartbeat is getting stronger — increased month-over-month existing home sales, higher values and more new construction on the way — there is still an ocean of underwater homeowners whose loans aren’t owned by Fannie or Freddie and who have no avenue to refinance. In addition, there are millions of homeowners who are underwater by virtue of home equity lines on their homes.

Nobody really pays attention to these people because the products they are in currently are adjustable-rate mortgages that offered an interest-only option. Before the mortgage meltdown, a very popular program that allowed buyers to purchase homes perhaps beyond their means was a 30-year fixed rate with a 10-year interest-only option. That meant borrowers were qualified on the interest-only payment vs. the true amortized payment.

Banks and investors

For example, if the rate was 6 percent on a $400,000 mortgage the principal-and-interest payment would be $2,398. However, the interest-only payment was a lower, more comfortable $2,000 a month. That’s a big difference, and it allowed millions of homeowners to purchase more expensive homes. Both Fannie and Freddie never really got heavily into those interest-only products, so the majority of those mortgages are held by numerous banks or Wall Street investors.

Now those homes have lost significant value, but the homeowners have been able to stay current and make the lower payments.

The same holds true for millions of homeowners who took out home equity lines back in the early and mid-2000s, when the major banks were pushing those products and allowing those lines to go up to 100 percent of the home’s value. Unfortunately, when the housing market crashed, people found out very quickly that the tiny print on their equity line agreement allowed the banks to freeze or reduce or do both to their line. Many of those frozen lines carried a 10- or 15-year draw while charging just the interest due each month — again, typically affordable. But after that, it is time to pay the outstanding balance back with a fully amortized payment, in a shorter time period.

What does this mean? It means that millions of homeowners are under a doomsday clock.

Take that homeowner with the $400,000 that he took out in 2005. Right now, he’s making that $2,000-a-month interest-only payment. But when that interest-only period ends in a couple of years, that $400,000 outstanding balance will now be amortized over the remaining 20 years of the loan at 6 percent.

Family budget

That new payment jumps to $2,865 a month. Ouch. How will that affect the family budget?

And if that particular homeowner has an equity line on top of that, you can figure that there is going to a significant jump in that payment as well.

Homeowners in this situation can’t refinance because they have lost equity. Their loans aren’t owned by Fannie or Freddie, so there is no pathway out. Consequently, they will either have to deal with the higher payments on their first mortgages or equity lines or sell their homes in a short sale — or perhaps go into foreclosure.

This is the other shoe that is getting ready to drop, and no one is preparing for it. In another couple of years, the housing industry, giddy that it is recovering, is going to get another punch to the gut because with no way to refinance and payments that are too big to handle, I would expect homeowners to start sending their keys back to those lenders just as they did in 2007 and 2008 and glut the market again with abandoned foreclosed homes. This will bring down values and start the cycle over again.

Not a pretty picture, but it is a very real possibility and one that surely the banks recognize is on the horizon. Do Washington and Wall Street let it unfold, or do they attempt to take a pre-emptive step to seek out these homeowners and put together a viable plan so the country does not suffer from Housing Meltdown: The Sequel?

Robert Nusgart is a loan officer with Mortgage Master Inc. in Baltimore. He can be reached at 443-632-0858 or by email at rnusgart@mortgagemasterinc.com. Visit his website at www.RobertNusgart.com for the latest mortgage and financial news.