Refinance Your Way Out of Trouble

Freddie is developing 30-year and 40-year fixed-rate as well as adjustable-rate subprime mortgages that will be available by mid-summer. The adjustable-rate mortgages will have limited payment shock by offering longer initial, fixed-rate terms, and the interest rates will reset less often and in smaller increments that traditional subprime loans.

The company announced late Wednesday that it has committed to purchase $20 billion of the new products in order to encourage lenders to offer them.

A Fannie spokesman said it wasn't clear how many subprime loans would be available, but its purchases could reach tens of billions of dollars over the next couple of years.

The initiatives come as an increasing number of subprime borrowers who took out loans with initial low, "teaser" rates are finding themselves unable to make their monthly payments once the rates reset.

Regulators are encouraging mortgage lenders to bend over backwards to help troubled borrowers by restructuring their loans. Still, refinancing may be the best -- and only -- option for many subprime borrowers who are having trouble making payments and want to stay in their homes.

That's because most of these loans are sold to a third party and repackaged into a mortgage-backed security, which may have rules dictating which remedies are available. (For a closer look at how Wall Street buys mortgages and repackages them as securities, see Booyah Breakdown: MBS 101, the first story in this series.)

As Sheila Bair, chairwoman of the Federal Deposit Insurance Corp., explained at the congressional hearing, modifying the terms of a loan used as collateral in a mortgage-backed security can jeopardize the tax-advantage status of these structures. So even if the investors stand to lose less money by allowing a problem loan to be restructured, rather than foreclosing, tax rules make it unattractive.