Wednesday, April 16, 2008

How To Fix The Foreclosure Mess

Being a political junkie, I'm fascinated by the various "fixes" offered by The Big 3 to help American homeowners out of the foreclosure mess. Hillary proposed a moratorium on foreclosures. Congress was debating allowing judges to renegotiate loan terms. Obama .... well, I like him lots but I forget what he proposed. And McCain just yesterday offered a plan whereby homeowners could "go to any post office" and fill out a simple form to apply for a new home loan.

Being in the trenches myself, so to speak, I'm not thrilled by any of these plans. Barack, I don't remember what you proposed to help homeowners but I still like your inspirational change message. Most economists say Presidents don't impact the national economy one whit, so I'd rather have someone inspiring sitting idle in the Oval. Billary: a moratorium is helpful only if the homeowner can resume making the payments at the end of the term.

John, I respectfully submit that most American facing foreclosure aren't having trouble applying for a new loan; they're having trouble getting one. Why? Because they can't afford the current payments, they frequently owe more on the house than it's currently worth, and to rub salt in the wound, they've dinged up their credit score badly by missing a few mortgage payments they can't afford.

My Plan To Fix The Foreclosure Problem (and maybe enter the presidential race)

  • A moratorium on foreclosures for 6 months

  • Sellers must attend counseling and sign an agreement to save their usual mortgage payment for the 6 months of the moratorium

  • Congress directs lenders to do the following: (1) write down principal, (2) lower interest rates and use fixed (not adjustable) rates, (3) lengthen loan terms, and (4) use the homeowners' credit score from before they missed their first mortgage payment to calculate the refinance terms

If done properly, both homeowners and lenders can win. It won't be easy but it's going to be awfully difficult to ride this out without doing anything. Under this plan, homeowners will build a little savings account to guard against future emergencies, and come out of it with a future mortgage payment they can afford.  Lenders get to charge & collect more interest over the life of the new, longer loan and write down a heckuva lot less in losses through principal write downs than through out and out foreclosure. (Some of the out of work mortgage lenders could get a new, temporary job as mortgage & credit counselers too, although they make a easy scapegoat in this crisis so that might be a hard sell on Capitol Hill.)

Handy Example - Homeowner owes $250,000 on a home currently worth $215,000 and struggles to make the monthly payment on their post-adjustment-period ARM loan, which began with a teaser rate of 5.125% but is now at 7.25%.

  • $250,000 loan at 7.250% for 30 years = $1705 a month, principal & interest

  • $225,000 loan at 6.000% for 45 years = $1206 a month, pricinpal & interest

While the homeowners are probably rejoicing at their $500 a month savings, notice that the lender wasn't forced to write down the entire pricinpal loss. The home is worth only $215,000 but the homeowner refinances $225,000. This should prevent the talking heads from ranting that we rewarded folks who knowingly got in over their heads. Importantly, this should help more Americans facing foreclosure actually stay in their house and keep making mortgage payments they can afford long into the future. Finally, fewer foreclosures equals less downward pressure on home values.

Sure, some homeowners won't save the money they'd normally spend on mortgage payments. Sure, some lenders won't write down the principal and/or interest enough to make a difference to the homeowner. Sure, some homeowners will still be so angry and (dare I use the word?) bitter that they'll still choose to walk away from their abode, stripping it bare on the way out the door. But I think it's better to try than to do nothing.

I'm sure there are other problems with my plan, holes I didn't see and issues I didn't think of. I'd like to know what readers think. I'm a relative guppie in the blogging world compared to some of the big fish who (graciously) read me. Want to leave your 2 cents? Please do! 

 This post inspired by my Dad, the Original Political Junkie. He's got a steel trap mind for everything that happened in the political arena since about 1954, and he should have been making millions in Washington as a policy wonk or a Senior Advisor on anything. He chose instead to quietly step in to help a formerly single Mom raise her 2 kids. I'd be lost without him.