By Dawn Kopecki

Feb. 24 (Bloomberg) -- President Barack Obama’s plan to use mortgage-finance companies Fannie Mae and Freddie Mac to refinance as many as 5 million loans may face legal challenges over whether the administration is overstepping its authority.

The proposal may violate requirements that homeowners put up at least 20 percent of the appraised value of a home or carry mortgage insurance, said U.S. Representative Scott Garrett of New Jersey, the ranking Republican on a panel that oversees the companies.

“I don’t see how that stands in face of what the statute says,” Garrett said in an interview. “It certainly seems as though they need to seek a congressional change, a legislative statutory change.”

Fannie and Freddie’s chief regulator, James Lockhart, has said the changes are exempted from mortgage-insurance rules written into the companies’ charters and won’t require new appraisals. Lockhart said the strategy will make it easier to help struggling homeowners get affordable mortgages.

The American Society of Appraisers, a trade group representing more than 5,000 appraisers, is weighing legal action to block the policy that would cost its members potential business, said Peter Barash, a lobbyist for the organization.

The group will decide whether to sue when the administration releases full details of the housing plan, scheduled for March 4, Barash said.

“We’re not there yet because we’re not sure what their policy is going to be,” said Barash, of the association based in Herndon, Virginia. “Determining loan-to-value is the linchpin of the plan, and in order to get a reliable value it makes sense to rely on professional appraisers.”

Loan-to-Value Ratio

Fannie and Freddie’s charters prohibit the acquisition of new loans with a loan-to-value ratio of more than 80 percent -- meaning the homeowner has less than 20 percent equity in the property -- unless mortgage insurance or some other credit backing is used.

Regulators will work around that requirement by treating the refinancings as a “modification for charter purposes,” not as new loans, Lockhart, director of the Federal Housing Finance Agency, said in a Feb. 20 letter to a mortgage insurance trade group.

The difference is that a modification retains the original contract, changing its terms. A refinanced loan requires an entirely new mortgage, which Fannie and Freddie would have to repurchase and repackage into a new security, according to analysts and the companies.

“The new refinanced loan is treated as a new origination because the old loan is paid off,” said Amy Bonitatibus, a Fannie spokeswoman.

Legal Opinion Sought

Representative Garrett said he is seeking a legal opinion that was prepared by Lockhart’s office.

FHFA, through spokeswomen Stefanie Mullin and Corinne Russell, declined to provide the opinion.

“The FHFA is an independent agency, and we defer to their judgment on its authority as the president looks forward to working with Fannie, Freddie and the FHFA to help millions of responsible homeowners make their mortgages more affordable,” said Nick Shapiro, a White House spokesman.

Fannie and Freddie’s charters say “in black and white, everything over 80 percent loan-to-value requires mortgage insurance, and you say, ‘No, there’s wiggle room there,’” said Julian Mann, who helps manage about $4 billion in bonds as a vice president at First Pacific Advisors LLC in Los Angeles.

The change in policy will cause some mortgage-bond investors to lose money as borrowers refinance at rates that are close to record lows and pay down higher-yielding securities, eroding the value of those holdings, he said.

“If you start playing fast and loose with written rules, you undermine the whole fabric of the capital-market system and you call into question contract law on everything,” Mann said.

‘Language Is Clear’

Fannie and Freddie’s federal charters are brief “and the language is clear” that any loan purchase must have either 20 percent equity or mortgage insurance, said Jim Vogel, an agency- bond analyst for FTN Financial in Memphis, Tennessee.

Washington-based Fannie was created in the 1930s under President Franklin D. Roosevelt’s New Deal to revive the U.S. economy. McLean, Virginia-based Freddie was started in 1970. The companies were designed primarily to lower the cost of home ownership by buying mortgages, freeing up cash at banks to make more loans. The two companies now own or guarantee about $5.3 trillion of the $12 trillion in U.S. residential mortgage debt.

The government seized control of Fannie and Freddie in September after their losses threatened to further disrupt the housing market, and then began pushing the companies to step up efforts to curb foreclosures.

No Appraisals Required

The Obama plan would temporarily allow Fannie and Freddie to refinance loans that they own or guarantee with loan-to-value ratios of as much as 105 percent without appraising the property or requiring additional mortgage insurance.

Borrowers who don’t have mortgage insurance on their current loans won’t need it under the plan, Lockhart said.

Without new appraisals, the loan-to-value ratios could be far higher than 105 percent, masking the companies’ true risk, said Paul Miller, an analyst at FBR Capital Markets in Arlington, Virginia.

“They’re a public policy arm of the federal government right now,” Miller said of Fannie and Freddie. “They aren’t being run for profitability.”

To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net.