Posted by: Bruce Allen | September 30, 2008

What’s Wrong With This Idea? Fix the Mortgage Mess!

Let's Put a Stop to This Mess!

Let’s Put a Stop to This Mess!

I’m wondering about the practicality of the suggestion that homeowners who are under water and unable to keep up with rising/confiscatory mortgage payments be converted temporarily to leasees, with a local bank as the lessor.The monthly lease payments would be held at some formerly affordable level while the market bottoms out.Housing and employment markets will at some point in the foreseeable future stabilize at a point where the homeowner is again solvent and, one hopes, interest rates are suitable for converting to a new, affordable fixed rate mortgage.

A New Class of Mortgage – the Neutral Mortgage

Such a product could be seen as a way station between a conventional mortgage and a reverse mortgage, a new status of “neutral” mortgage in which the owner voluntarily becomes a tenant for a number of years while the markets stabilize.  An arrangement established as part of a federal housing market recovery program.

The idea is to incent banks to resume their former model of making, selling and servicing mortgage loans in their markets, the de-collateralization of the industry, complete with financial underwriting.Next, it intends to keep people in their homes until order returns to the real estate market.Finally, it provides for the tenant to become the owner again, with a new, smaller mortgage loan within, say, five years.It would specify insurance and property tax payment arrangements, etc.

How Would the Neutral Mortgage Work

  • The bank keeps the owner in the home, maintaining it, and securing positive cash flow.
  • The bank gets to sell the new mortgage at the time it becomes feasible.If the bank chooses to enforce an artificially high rate of interest, the owner is free to re-finance elsewhere at no cost within a year (?)
  • The plan allows homeowners cum tenants to continue to take the mortgage interest deduction on the loan.This would be Federal dollars at work, permitting those who comply with the regs to maintain an after-tax standard of living that makes sense.
  • The bank would purchase underwaterand foreclosed mortgages in its market area from wherever they currently reside, at a discount.The bank would then execute Federal Form leases, with standard language, with the owners.The houses would serve as the security deposits, and the monthly payments would be established per regulatory language.
  • Provision for default of lease terms would be needed; a number of families won’t be able to keep up with even an adjusted series of payments.The turmoil in financial markets is expected to reach employment markets very quickly, and job losses are expected to grow.Separate provision could be made for tenants who lose jobs and thus the ability to continue payments, etc. etc.

What would be the actual Federal costs involved?There would be a buydown of CMOs, reflecting the loss in home values, and writing down for usurious and predatory loan terms, execrable underwriting practices, and morally offensive behavior on the part of executives throughout the financial industry.For example, a home that was previously worth $300,000 and had a $290,000 mortgage is now worth $225,000.The difference between the $290K and the $225K is the buydown–$65,000 in this example.

Local banks become titular owners of these homes, making a new mortgage for $225,000.The former owners would pay “rent” equal to the interest payments only on the new loan, plus taxes and insurance.At that point, give the homeowner 5 years to assume the new mortgage, which is still $225,000.The point where that makes sense will be a function of interest rates and home prices.Given the behavior of markets during the recent bailout arguments, it is pretty clear that interest rates may be going up as soon as a deal is in place.Worst case, such a program forestalls another round of foreclosures for five years, while looking for other solutions.Such solutions might include subsidized interest rates on new FHA loans, etc.

The depth of the provisions will parallel the depth of the problems, which appear to be potentially extreme.The housing market is not behaving as though a bottom is imminent.I say this, in part, due to my regularly being wrong about this type of thing, and hoping that in the immediate case I am wrong.

Once the housing market bounces off its bottom, so to speak, the scope of the problem will be more clear.Until then it’s a devil we don’t know.And it may take a year or two to get to know this particular devil.

Keeping the devil from the door of working people seems to be a worthy expenditure of federal funds at this point in time.

Bailout: What’s in it for homeowners
How Much House You Can Afford?

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