Recommendations and Actions
Under the Section 235 Program, qualified homeowners have their monthly mortgage payments reduced by the Department of Housing and Urban Development (HUD). HUD makes a monthly interest reduction payment to the lender on behalf of the homeowner. That lowers the homeowner's effective interest rate and, thus, monthly payment. The effective interest rate for the homeowner is set based on the income of the homeowner. Obviously, the higher the interest rate being charged by the lender, the greater HUD's interest reduction payment to lower the effective rate. Many of the home mortgages covered by this program were taken out during the high-interest periods of the late 1970s and often have interest rates in double digits, with some as high as 18 percent.
It would clearly be in HUD's financial interest to replace the high- interest loans by refinancing with new lower-interest loans. That would reduce the HUD interest reduction payment. For example, if a homeowner has a $50,000 loan for 25 years on which payments are made as though the loan was at 5 percent interest, the homeowner's payments would be $292.30 per month. If the loan was actually made at a 14 percent interest rate, the lender will require a monthly payment of $601.88. The difference of $309.58 must be made up with the HUD interest reduction payment. If that loan were replaced by a loan at 8 percent interest, the payment to the lender would be $385.91 and the HUD interest reduction payment would be $93.61, a reduction of $215.97, or 70 percent. The longer HUD waits to refinance, the smaller will be the savings.
Arranging refinancing is a time-consuming process. A new lender must be found, forms filled out, the property appraised, repairs made if required by the lender, and the title checked and cleared if additional liens have arisen. The homeowner has little or no incentive to refinance because refinancing does not change the effective payment for the homeowner. The lender collecting the high interest certainly has no desire to refinance. HUD, however, is losing large amounts of money by making large interest reduction payments on high-interest rate loans compared to replacing the loans with current, lower-interest rate loans.
HUD has a severe shortage of staff for its workload, and the steps needed to refinance these small transactions (if not done by the homeowner) are staff intensive compared with many other high-dollar problems which HUD must also address. HUD has thus found it difficult over the years to accomplish very much of the refinancing needed. The function seems ideally suited for an incentive contract in which the return to the contractor would be based on a percentage of the calculated savings to be achieved by HUD from refinancing, after subtracting out all of the costs of refinancing to HUD. The contractor would have sufficient incentive to undertake all the
needed steps: finding a new lender, getting the forms filled out, arranging appraisals and repairs and getting the homeowner to sign the documents. The homeowner will need to be given enough financial incentive to provide information and execute documents.
1. HUD should be given flexibility to induce profitable refinancing of Section 235 Program loans by paying whatever contract costs and incentive payments to Section 235 borrowers may be cost-effective.
For example, it might be productive to let a contract in which the contractor shares in a percentage of the net benefit to HUD. The contractor might find it advisable to pay one borrower a large incentive fee to cooperate while another loan (with a smaller net return expected) might only justify a very small incentive payment to the borrower. All such payments should be allowed.
2. HUD should issue one or more incentive contracts to private companies.
This flexible incentive contracting approach will make effective use of the private sector to rid HUD of a long continuing embarrassment and reduce avoidable costs to the taxpayers by taking advantage of current favorable interest rates.
Annual savings are derived from estimating the total annual subsidies provided on currently outstanding loans that have mortgage rates above 10 percent and an average of 10 years remaining. Future costs were also projected on an annual basis assuming those loans are refinanced at an interest rate of 8 percent. The difference between the projections at current rates and the projections at the 8 percent refinanced rate is the projected savings. The total potential savings are reduced to reflect a 30 percent commission to the private sector company(ies) conducting the refinancing program, some of which would be provided to owners as a refinancing incentive.
Budget Authority (BA) and Outlays (Dollars in Millions)
Fiscal Year 1994 1995 1996 1997 1998 1999 Total ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ BA n/a -105.0 -105.0 0.0 0.0 0.0 -210.0
Outlays n/a 30.0 15.0 -30.0 -30.0 -30.0 -45.0
Change in FTEs n/a 0 0 0 0 0 0
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