The Home Affordable Refinance Program was instituted in 2009 to allow home owners with negative equity to take advantage of today’s low interest rate environment. Before HARP, banks would not lend more than the home’s value. In real-estate jargon, they won’t underwrite loans with a loan-to-value ratio (LTV) greater than 1.0. So if a homeowner bought their home in 2006 with a 6.5% mortgage rate, they would be unable to refinance if they owed more than the home was worth. HARP was created with these people in mind. Since inception, the HARP program has refinanced 2.2 million mortgages.
To be eligible for HARP, the borrower must have a loan guaranteed by Fannie Mae or Freddie Mac, have an LTV ratio above 80% and be current on their mortgage. The program was designed primarily to help people who wanted to stay in their home, had adjustable-rate mortgages where they could afford the initial “teaser” rate but would not be able to afford the payment once the mortgage adjusted upward. The program had the effect of giving them a new 30 year fixed rate mortgage at the initial teaser rate. Home owners can check if they have a Fannie Mae or Freddie Mac loan by checking the Fannie Mae or Freddie Mac website or by checking with their servicer.
HARP program has just been extended for two more years
The HARP program was set to expire Dec 31, 2013. Today, FHFA extended the program until 12/31/15. “More than two million homeowners have refinanced through HARP, proving it a useful tool for reducing risk,” said Acting FHFA Chairman Ed Demarco. Chairman DeMarco has been under pressure to allow principal modifications for Fannie Mae and Freddie Mac loans, but has so far resisted. His responsibility is to look out for the taxpayer, not necessarily borrowers.
In Q4, HARP refinances accounted for 22% of all refinance activity in conforming (Fannie Mae or Freddie Mac) loans. In the hardest hit states (Florida and Nevada), they accounted for over half the refinance activity. The Administration is considering extending HARP to borrowers with non-government mortgages.
Implications for mortgage REITs
Refinancing activity affects prepayment speeds, which is a critical driver of mortgage REIT returns. Prepayments are due to the fact that home owners are allowed to pay off their mortgage early without penalty; when interest rates fall, those that can refinance at a lower rate will do so. This is something that is good for home owners, however, it isn’t necessarily a good thing for mortgage lenders, especially REITs. When home owners prepay, the investor loses a high-yielding asset and is forced to re-invest the proceeds in a lower rate investment. This means lower returns going forward. A rise in prepayment speeds could be negative for REITs, like American Agency Capital Corp. (AGNC), Annaly Capital Management, Inc. (NLY), Hatteras Financial Corp. (HTS), CYS Investments, Inc. (CYS), and Capstead Mortage Corporation (CMO).
The other implication is that REITs may take capital losses on some of these mortgages. Ordinarily, a government guaranteed mortgage with a coupon rate well above market rates will trade above par, as long as the loan to value ratio was over 1, because it couldn’t be prepaid. (Think about our example above with a person who took out a mortgage at 6.5% in 2006 – that mortgage would be worth close to 110.) If a REIT has that mortgage marked at 110 and the loan refinances, they will take a capital loss of ten points.
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