Washington has been hard at work for a while on this huge housing rescue legislation - it'll provide $300 billion to distressed homeowners who face a possible foreclosure - and it passed the House this week. Once it gets the blessings of the Senate and the White House, it'll become law, which it is expected to do soon. Besides coming to the aid of financially-hurting homeowners, it'll also extend a helping hand to the ailing mortgage heavyweights Fannie Mae and Freddie Mac, something they both badly need.
The bill includes a lot of rules about all sorts of things, as it should so everything is as clear as possible. One area that caught my eye is the cost to the borrower.
To start with, under the legislation eligible homeowners can refinance their high-cost old mortgages to new, lower-cost fixed-rate home loans insured by FHA, or Federal Housing Administration. FHA will charge each borrower 1.5% of the principal amount each year as an insurance premium. That in itself is pretty much in line with what FHA is currently doing with their standard programs.
Here comes the intriguing part that gets everyone talking. It involves profit sharing on any future price appreciation. When the home is sold or refinanced, the owner is to pay FHA a "3% exit fee" based on the remaining principal. There is more. If the owner sells or refinances within the first year, he'll have to dish out to FHA 100% of any profits. In other words, all the potential gain is gone, less the cost of sales. During the second year the owner would owe FHA 90% of any profits and the third year it would be 80% and go down 10% each year until it reaches the fifth year when the percentage is 50 and then it would remain there for the duration.
The legislation is designed to assist homeowners who find themselves on the edge and for those who qualify, it'll accomplish its mission. But as is evident from the cost scenario, FHA will seemingly collect enough premiums and potential profit margins to cover any future loan losses, which it should do so it won't become a direct taxpayer burden. The plan, however, relies heavily on the real estate market recovering nicely in the coming years. It'll probably do so, at least in the faster-growth areas and the higher premiums and profits they collect there would then be used to cover mortgage losses in the slow-growth regions. From this cost angle alone, the program is very workable.