In the years following the housing market crisis, the Home Affordable Refinance Program (HARP) proved to be a highly effective tool in preventing mortgage defaults, with more than 3.4 million borrowers from 2009 to 2018 taking advantage of the refinancing opportunities provided by the program.  HARP offered simplified documentation, automated appraisals, no or reduced loan-level pricing adjustments, and mortgage insurance transferability without regard to the mortgage’s current loan-to-value ratio. Rigorous studies have estimated that this program, by reducing borrowers’ monthly mortgage payments, reduced the default rate on these mortgages by as much as 62 percent. Although policymakers have acted quickly to enact other forbearance programs during the COVID-19 pandemic, HARP or a similar program has not been restarted, despite its previous success.

Mortgage rates remain near historic lows, creating an opportunity for borrowers to lower their interest and monthly mortgage payments and improve their financial stability. Borrowers who have taken advantage of refinancing have tended to have high credit scores and large loans and have not suffered a job loss or income reduction. Households most affected by the pandemic’s economic effects are likely to have been locked out of refinancing opportunities. Because of historical inequities that have limited economic opportunities, these borrowers are disproportionately Black and Latino. By introducing a streamlined refinance program modeled after HARP, policymakers could address these barriers and help borrowers with low credit scores, low incomes, and small loans, who are disproportionately Black and Latino, strengthen their financial situation and avoid defaulting on their home loans.    

Streamlined refinancing could reduce default risk among borrowers with low credit scores

Tight credit is a major barrier for many borrowers who want to refinance their mortgages, even though they already have a loan and the rate reduction would make borrowing less risky. Even before the pandemic, credit was tightening, and it has tightened considerably more during the pandemic, particularly for refinancing.

In January 2019, Urban Institute calculations indicate 29.3 percent of Fannie Mae refinancing loans had credit scores below 700. That share dropped to 14.8 percent in January 2020 and to 9.4 percent in January 2021. For loans with layered risk, the tightening was even more dramatic. In January 2019, 13.6 percent of Fannie Mae refinancing loans had FICO scores below 700, which declined to 6.3 percent in January 2020 and 3.2 percent in January 2021.

As a result, borrowers with high credit scores are more likely to be able to refinance than their counterparts with lower scores. For Fannie Mae borrowers with loans originated in 2018, 51 percent of those with credit scores below 680 remain outstanding compared with 31 percent for borrowers with credit scores of at least 760. Borrowers with low credit scores are already more likely to default than borrowers with higher scores, so a streamlined refinancing program that lowered mortgage payments would disproportionately benefit these borrowers and reduce their likelihood of default.

2018 Mortgage Origination: Cohorts with Lower Credit Scores Have Refinanced More Slowly (Outstanding Balance/Original Balance)

Source: Urban calculations from eMBS data.

These risks are more likely to affect Black and Latino borrowers. Consumer Finance Protection Bureau data show that Black and Latino borrowers tend to have lower credit scores than white borrowers. Home Mortgage Disclosure Act data show that at origination, differences in mortgage rates by race and ethnicity are small and can be at least partially explained by differences in credit characteristics. But the differences for the distribution of outstanding loans are larger, indicating that Black and Latino borrowers have more difficulty refinancing. Although we have focused on credit scores because data are available, similar issues relating to loss of income also have prevented refinancing.

A streamlined refinancing program would benefit these borrowers more and could stimulate economic activity as more borrowers refinance, save money on their monthly payments, and convert some of those savings into spending. Borrowers who are in weak financial positions are more likely to use mortgage savings for immediate consumption that those in stronger financial situations. And with many low-income borrowers experiencing income or wage losses during the pandemic, additional savings could help them meet basic needs.  

A new streamlined refinancing program could mitigate the pandemic’s economic effects for borrowers

A streamlined refinancing program could greatly benefit borrowers with low credit scores and those who have lost income, and it would pose only a small cost to the government-sponsored enterprises (GSEs). Rate-lowering refinancing loans reduce the default risk on loans the GSEs have insured. But the GSEs have sold off much of this risk to credit-risk transfer programs already, so the GSEs would be forced to take the risk back on their own balance sheet or include them in new risk transfer pools at less favorable terms if a refinancing program was introduced. The actual costs to the GSEs would be small, especially given recent robust house price appreciation, and would be in the public interest. The GSEs can also price for these streamlined programs when setting their guarantee fees.

Unlike after the Great Recession, when low or negative equity made refinancing difficult, some of today’s borrowers, especially Black and Latino borrowers, cannot refinance because of low credit scores and high debt-to-income ratios resulting from the loss of employment or income. As this administration focuses on racial justice, introducing a streamlined refinancing program that builds on the lessons of HARP could address pressing financial needs, particularly for Black and Latino homeowners, while rates are still low enough to make the program effective.