LEGAL NOTES

Starting October 1, as many as 400,000 borrowers facing foreclosure may be eligible for a more affordable loan backed by the Federal Housing Administration (FHA). But is this really a viable option for those in need?

President George W. Bush recently signed the Housing and Economic Recovery Act of 2008, which aims to alleviate the foreclosure crisis by allowing consumers to replace their subprime loans with 30-year FHA-backed loans. However, the act may do little to alleviate the foreclosure problem for most consumers, as refinancing into the new program comes with many strings attached.

During the housing boom, subprime loans were given out liberally to people with poor credit and insufficient means to pay their monthly mortgage payments. As home prices continued to skyrocket over a period of several years, consumers mistakenly thought that Real Estate investments were a sure thing. Many bought homes they could not afford under the assumption that they could refinance when their home values went up.

Unfortunately, for millions of Americans, this never happened. In the past few years, the housing market has drastically declined, partially due to a credit crunch caused by these subprime loans. Because people took out loans they cannot now pay back, many have been forced to foreclosure, dragging down home values, or leaving people with mortgages that are greater than the value of their homes.

The Housing and Economic Recovery Act of 2008 was passed in an effort to help consumers avoid foreclosures, primarily by authorizing the FHA to insure distressed mortgages if the bank replaces the existing loan with a 30-year, fixed-rate mortgage equal to 90 percent of the home’s current market value. For instance, if an owner facing foreclosure has a $250,000 mortgage on a home that is only worth $200,000, the bank could convert this loan to $180,000 fixed-rate mortgage.

However, while the Act is certainly a step in the right direction, it is important to note that these loans do not help everyone. The act only applies to owner-occupied homes that were bought between January 2005 and June 2007. In addition, an owner’s current mortgage payments must be at least 31 percent of the household’s gross monthly income, and all other debts on the home must be paid off first.

If the borrower sells the home or refinances the mortgage, he or she must pay the FHA an exit fee (3 percent of the mortgage balance), as well as a share of the profits if the home goes up in value. This share is determined by the amount of the time that has passed since the loan was taken out (100 percent if done within a year, 90 percent if within two years, and down to 50 percent in the fifth year or later).

You may ask: why would a bank accept these terms? Here’s where it gets tricky. The Act assumes that the bank wants to avoid an expensive foreclosure and obtain the FHA’s insurance that the loan will be repaid. In exchange, the bank would take a loss on the overall value of the loan and pay an FHA fee that is equal to 3 percent of the home’s current market value.

While this might be a viable option in some situations, it probably will not be too helpful in cities that have been hardest by plummeting home prices, such as Las Vegas, because many mortgage balances in these areas are far greater than the home values. For example, a homeowner could have a mortgage of $400,000 for a home that is worth $280,000 now. In these cases, it is unlikely a bank will write off such major losses.

In addition, the new program is solely designed for primary residences, not investor-owned properties, which have been hit hard by threats of foreclosures, especially in Las Vegas and other cities in Nevada. For these homeowners, the act provides little or no relief.

Finally, many of the people who secured subprime loans in the past few years took out second mortgages—and usually with different financial institutions. In these cases, it is unlikely that the second-mortgage lender will agree simply to write off the loan, especially if they do not also hold the first mortgage.

While the act may do little to help many homeowners facing foreclosure, it may help stimulate purchasing activity by providing a tax credit for first-time homebuyers. The credit would reduce the amount of tax owed on a home by 10 percent of the purchase price, up to a maximum of $7,500. The credit is $3,750 for married couples filing separately. Unmarried people who jointly purchase a home will be able to split the $7,500 credit.

When you read the fine print, it turns out that the tax credit is actually more like an interest-free loan, as buyers would be required to repay the government over 15 years in equal installments for whatever amount they receive.

The bottom line is that, while the new act will help some, it will do little to help the people who are most in need of foreclosure relief, and will not likely be able to be utilized much in Las Vegas.

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Disclaimer: The above is not intended to be, nor is it legal advice, and should not be relied upon for any reason. Even though this article maybe disseminated throughout the U.S., the material covers only Nevada law, and no other. E RealEstateExec and Exec MediaGroup, LLC expresses no opinion on any other state's law, nor about the handling of any particular legal situation. You should consult your attorney, accountant or business advisor before undertaking any action. No attorney-client relationship is created between E RealEstateExec, Exec MediaGroup, LLC and the reader.