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Refinance Your Way Out of Trouble

Fannie Mae and Freddie Mac are rolling out new products aimed at subprime borrowers.

Editor's note: As a special feature for April, offers a 20-part series on virtually everything about real estate. Today's installment is part 11.

Homeowners with high-risk mortgages are about to get some more options to help them keep their houses.

Fannie Mae



Freddie Mac


are coming out with new products designed to make it easier to avoid foreclosure by refinancing subprime loans.

Fannie and Freddie don't lend money; they are chartered by Congress to buy mortgages from lenders, freeing them up to make more loans. The mortgages are then repackaged into mortgage-backed securities and sold to investors.

Right now, both housing agencies primarily purchase so-called conventional mortgages, which are loans to borrowers with good credit. By committing to purchase subprime loans with relatively friendly terms, they are providing a potential lifeline to troubled borrowers.

Fannie is adjusting its credit requirements for some existing products aimed at subprime borrowers so that more people will qualify for this option once the changes take effect later this year. It also plans to broaden the number of lenders offering the products to 2,000 from 500.

"Our message to lenders with borrowers facing resetting

adjustable-rate mortgages is this: 'If your homeowner has managed his credit over the past 12 months, there's a good chance Fannie Mae can help,'" Mudd said in testimony before the House Financial Services Committee earlier this week.

Mudd said Fannie is currently getting about 15,000 applications a month for subprime refinancing; about 80% were being approved even before recent enhancements. The housing agency estimates that about 1.5 million homeowners who face resetting ARMs and potential payment shock this year and next could be eligible for its loan options.

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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.

In some cases, loan servicers also need to get the approval from credit ratings agency or bond insurers before modifying the terms of a mortgage being used as collateral, creating additional barriers to workouts.

Barr said about 75% of the estimated $600 billion in subprime loans originated in 2006 were funded by securitizations.

An increasing number of borrowers are also using Federal Housing Administration loans to refinance out of subprime mortgages. Assistant HUD Secretary Brian Montgomery told the House Financial Services Committee that FHA refinance loan volume was up 94% in the first five months of the agency's fiscal year over the year-earlier period. He said it's "safe to assume" that a significant portion of the loans being refinanced are subprime.

The number of subprime borrowers the FHA can help is currently limited because of limits on the size of loans it can insure and the requirement that borrowers make a down payment. Lawmakers are debating an overhaul of the FHA that would increase loan limits and give the agency more power to set insurance premiums commensurate with risk. Montgomery said this would allow the agency to "dive deeper into the pool of homeowners who could benefit from a refinancing of their subprime loan."

Still, even with an FHA revamp and new products from Fannie and Freddie, a number of subprime borrowers won't be able to refinance their way out of trouble because their loans carry prepayment penalties or because they are "upside down," meaning they owe more money than their house is currently worth.

Coming up next: homeowner's insurance.

Allison Bisbey Colter joined in 2006 from the New York office of Dow Jones Newswires, where she spent the previous seven years covering consumer finance, mutual funds and hedge funds. Prior to that, she worked in Europe for Dow Jones covering transportation from London and Italian capital markets from Milan. She is a graduate of Wesleyan University, where she received a BA in government.