Let me give everyone one a little back ground on myself. I am a chemical engineer employed full time in that role. But I also am the owner of several rental properties. This doesn't make me an expert on housing, but I do have about 11 years experience in the housing/rental market. My experiences stretches from the dot com era when "everyone" was in the stock market and real estate was an after thought, to "housing euphoria" day, up until today's mortgage melt down. During this whole time my strategy has been buy and hold. I have only sold one property to realize some gains in the last 11 years.
There are several places to put the blame for this housing mess. This isn't a diary designed to place blame rather it's an attempt to offer some policy prescriptions on how to fix this mess. I do have some disagreements with President's Obama's plan.
MY PLAN
- Changing the interest banks charge people is a good idea. Lifting the 20% equity requirement to refinance is a good idea. This will let people refinance at a lower rate.
- Mortgages should be extend up to forty years from today 30 years this will cut payment amounts. This should be used only as a last resort for people who are in trouble. It should only restricted as not not create a 40 year mortgage housing bubble.
- Allowing bankruptcy judges to "cram down" mortgages (reducing the principle) is an acceptable idea. But only if a hard limit on the reduction amount was placed on this.
In order to figure out saving rates, I am going to use this link Mortgage Calculator.org
I will use a fictional house costing $250,000 as my starting point. If you disagree with what I have proposed or want to try out your own ideas feel free to work these numbers out on your own.
At the height of the mortgage boom, a variable rate mortgage on a $250,000 home, at 4.5% with no money down would have meant a monthly payment of $1631.30.* If some one purchased a home expecting this level of monthly payment, a fair plan would find a way to get back to this level of payment. A person who can't afford the original payment level now (excusing people who lost their job of course) should have no excuses. They shouldn't have gotten a mortgage in the first place.
The above monthly rate included an assumed 1.25% property tax and a PMI rate of 0.5%.
If the rate had reset 7.5% (this was a variable rate mortgage) it would have gone to $2,112.62. This jump of $481.32 a month is what is behind most of the foreclosure crisis. Most people who have these types of loans can afford another $481.32 in mortgage cost. But with the 20-25% drop in housing values, they are not eligible to defiance.
So let's look at how my plan would work on this $250,000 house:
- If they are able to refinance down to a 30 year fixed rate of 5.25% there new unfordable rate of $2112.62 would be reduced down to $1,745.09. Still more than the $1631.30 but only $113.79. Yes I know this is part of our president plan
If they still are not able to afford this rate, extend the terms of the loan to up to 40 years.
- This same loan at a 5.25% rate for 40 years would be $1,611.76. This would be less then the amount they were first paying. This would require some government action. Fanny Mae and Freddy Mac would need to issue 40 year bonds to create a comparative market. But to be truthful a 40 year mortgage would most likely have a higher interest rate the a 30 year so I will assume a true rate of 5.75% and get a payment of $1,696.80 per a month.
If this still was to much and a person went bankrupt, I would allow a judge to issue a "cram down" principle. I would limit it to about 10% of the principle. The problem with allowing larger amount of principle reduction, is that it would reward speculators when the market recovers. Also a solvent bank (not over extended) needs about $1 in assets for every $10 it lends. This would remove the profit from a bank, but not reduce it so much that it would not be able to extend new loan.
- This same mortgage on a $250,000 home now reduce (crammed down) to $225,000, at 40 years, and at 5.75% would now have a monthly payment of $1,527.12. A savings of $104.18 from the original amount of $1631.30. This is a best case scenario post bankruptcy.
I think a plan that addressed housing in this order would be fair. It would not cost the over extended tax payer as much money as some other ideas. I furthermore believe it would create less moral hazards.
In normal ever day economic activity if a friend has trouble repaying a loan you make to them this would be the order a prudent person would make. Reducing any interest charged, then giving them more time to repay you, then finally excepting partial payment. I strongly propose a solution based on these principles.
Our president's plan does support interest rate reduction. But I think term extensions, and a limited cram down provision. Would improve it. I do believe in a hard cap on cram downs. If one person got only a 5% reduction, and another judge decides to reduce a similar person mortgage by 50%, there would be a legitimate question of fairness. I don't think that this issue should be left only to a judges discretion. I furthermore believe my plan would cost less then the $75 billion dollar currently being quoted. It would most likely cost about $20-30 billion instead.
UPDATE
Just to preempt an argument, there is an idea that if a person's home is worse less then their mortgage they will walk away. This is an argument for cram downs as the best solutions. I disagree, I think getting foreclosed on is such a traumatic experience (I have had to evict people it sucks), most people will avoid it at all cost, especially if children are involved.
Secondly I think offering refinancing to everyone build political support. Even people who scrimped to pay their mortgage would get "rewarded." Reduced payments would be a stimulus (see the 1990's refinance boom). I think supporting 40 years mortgages for everyone would be a mistake. It could create another false boom. It would allow people to buy more house for a lower monthly payment increasing debt.
UPDATE #2
From the comments section the idea was formed that the cram downs should be structured as a second mortgage. I would support this. I would make it a 15 year non interest loan. That would be callable only after the house is sold. It would require no monthly payments, and would have its principle reduced each month by an annualized term amount. This would in effect place a lean on the house to force repayment of the cram down. I would allow this to be an option for any thing that is over and above the first 10% cram down in principle forgiveness.