Feb. 4 (Bloomberg) -- Homeowners with Fannie Mae and Freddie Mac mortgages bigger than their property’s worth must wait for the companies and their regulator to assess the possible “unintended consequences” of allowing them to refinance into lower payments and related “hurdles,” Federal Housing Finance Agency Director James Lockhart said.

While FHFA and the two largest mortgage-finance companies are considering permitting so-called underwater borrowers whose loans Fannie Mae and Freddie Mac already own or guarantee to refinance, the companies haven’t yet submitted formal proposals seeking the right, Lockhart said. The change could harm mortgage-bond owners and also affect mortgage insurers, he said.

“One of the things we’ve seen a lot is unintended consequences, so I think we want to go through that to make sure there isn’t an unintended consequence here,” Lockhart said in a Feb. 2 interview.

It’s surprising the rule revision hasn’t happened already, because it would reduce the companies’ default costs and boost the U.S. economy by allowing more consumers to benefit from mortgage rates near record lows, said Ajay Rajadhyaksha, the head of fixed-income strategy in New York at Barclays Capital. Almost one in six U.S. homeowners with mortgages owe more than their homes are worth, Zillow.com said in a report yesterday.

“It’s not logical,” Rajadhyaksha said in a Feb. 2 telephone interview.

‘Various Hurdles’

The companies and FHFA are “looking at the various hurdles and unintended consequences,” Lockhart said. Those include the fallout on Fannie Mae and Freddie Mac mortgage-bond holders “and the implications to mortgage insurers -- those things need to be thought through,” he said. It’s a “reasonable idea,” he added.

The U.S. took control of Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac in September as their losses threatened to further roil the housing market. The government agreed to inject as much as $200 billion of capital to protect investors in their roughly $6 trillion of corporate debt and mortgage bonds.

In November, the U.S. drove the borrowing costs of Fannie Mae and Freddie Mac to records relative to benchmark rates by offering to guarantee bank debt and thus create more government- supported investments for bond buyers to choose among. That contributed to rising mortgage rates for typical borrowers before the Federal Reserve announced a plan to buy $500 billion of home-loan bonds that reduced rates to record lows.

Possible Bondholder Losses

Mortgage-bond holders who pay more than face value for the debt may incur losses if refinancing means the securities are repaid faster than expected, cutting the value of the premium coupons on the debt. More than 95 percent of Fannie Mae or Freddie Mac-guaranteed fixed-rate mortgage securities are trading above face value, according to Bloomberg data.

“The owners of mortgages include mutual funds, university endowments, pension funds and retirees on fixed incomes,” said Don Brownstein, chief executive officer of Structured Portfolio Management LLC, a Stamford, Connecticut-based manager of hedge funds. “They would almost all take a hit from a refi wave induced by a change.”

There would be no stimulus provided to the economy as the investors’ losses offset the consumers’ gains, he added.

Another thing “you have to think about is what happens to the mortgage insurance, if you have mortgage insurance,” Lockhart said. He declined to be specific.

Effect on Insurers

Fannie Mae and Freddie Mac loans taken out with less than 20 percent down payments or home equity generally require mortgage insurance. That means insurers such as MGIC Investment Corp. or PMI Group Inc. backing debt outstanding may need to agree to insure a new loan, to allow underwater borrowers to refinance. A program that waives appraisals may cut into the insurers’ opportunities for new business.

While Fannie Mae has been allowing some refinancing of underwater borrowers in a “pilot” program, Lockhart said, neither the company nor Freddie Mac has offered plans for all such homeowners as they and FHFA deal with creating a flurry of other new programs intended to aid the housing market, such as protocols for servicers to rework delinquent debt.

“They’ve said that they intend to have the proposals, but we haven’t seen them yet,” he said.

Brian Faith, a spokesman at Fannie Mae, declined to comment.

“We’re looking at this among many other alternatives to keep more borrowers in their homes,” Sharon McHale, a Freddie Mac spokeswoman, said in a telephone interview yesterday.

Lockhart said the change wouldn’t require lawmakers to take action, such as to revise the companies’ charters. Under the law, the companies must have borrowers or lenders buy mortgage insurance or other forms of so-called credit enhancement if down payments or home equity are less than 20 percent. Mortgage insurers cover all or some of lenders’ losses on defaulted debt.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

Last Updated: February 4, 2009 17:14 EST