Wednesday, February 25, 2009

The Rescuers

I live in a nice house. It's not a mansion, but a nice house. I also live in a nice neighborhood. It's not millionaire row, but its nice. At the peak of the housing market, I was making good money, and I thought very seriously about moving to a larger, more expensive home in the subdivision adjacent to mine. As the market slowed I thought even more seriously about it, because I thought I could find a bargain. In the end, I decided that I was better off in my older, more modest home. What a great decision that was! Six months later I was laid off. Now I have started my own company. Those of you that are self employed understand what it is like to not get a regular paycheck even though you work. Any money I make goes back into my company, and it has been seven months since I have seen a paycheck. I should be the perfect candidate for a government bailout.

Alas, despite the lack of income I have paid all of my obligations on time. I had plenty of savings (and still have some) to get me through this. If I had only known that the federal government would be pushing loan modifications, I wouldn't have wasted my money on something as useless as savings. I would have bought that big beautiful house on millionaire row. I blame my parents for instilling me with financial sense and personal responsibility. Little did they know how useless those virtues would be in 2009.

Now that I have resigned myself to the fact that I won't benefit from any financial rescues, and will in fact be paying for the rescue of others for years to come, I can objectively review the President's announced Homeowner Affordability and Stability Plan. The plan covers three key areas: creating opportunities for homeowners to refinance; encouraging a larger number and more effective loan modifications; and strengthening of the governments commitment to Fannie Mae & Freddie Mac.

The first part of the plan is the affordability initiative. Loans that are currently owned by Fannie or Freddie or in mortgage back securities guaranteed by the government sponsored enterprises will be eligible for a refinance to current interest rates, which are very low by historical standards. A lack of equity is keeping many people from refinancing, so the President's proposal is to allow for loan amounts up to 105% of the current value. That will certainly open up the opportunity for some homeowners to refinance. It will leave out quite a few as well. For example, people who don't have a conforming loan (Fannie or Freddie) currently will not be eligible. Also, if they are so upside down (owe more than the house is worth) that 105% is not sufficient, they won't qualify either. There are a lot of homeowners here in Arizona that fall into that category. Jumbo loans are also not eligible (over $417,000). The Mortgage Bankers Association has argued that the 105% limit should be removed from the plan. Their argument is that Fannie Mae and Freddie Mac already have the liability for the existing loans no matter what the loan to value ratio is. Therefore it is in their best interest to refinance these loans to lower rates regardless of how much the value of the home has declined. That's a pretty valid argument, especially since there is already a precedent set in the form of FHA and their streamline refinance program.

The second key to the plan is to increase the number of and the effectiveness of mortgage loan modifications. Many people have fallen behind on their mortgage payments and the only thing that will save them from foreclosure is a lender that is willing to change the terms of the loan and make the payment more affordable. Obama's plan calls for lenders to modify mortgage payments down to 38% of the borrower's gross income. In addition, the government will match dollar for dollar a reduction of the payment to 31% of the borrower's gross income. There are additional incentives that can be paid to the lender if the modification is successful (meaning the borrower makes the payments and stays in the house) as well as incentives for the borrower (beyond being able to keep their house) in the form of principal reductions for successfully paying their modified payment on time. It's a positive to get some guidelines on what has been a messy and confusing subindustry called "Loan Modifications." Lenders will continue to struggle with the problem of filtering true hardship cases versus those individuals that look to take unfair advantage of the lender and taxpayer. And the borrowers with the true hardship cases are not likely to comprehend how the plan works anyway. If they claim to have not understood their original mortgage that got them in trouble, how are they going to understand this?

Low Rates
The final part of the plan will likely be the most effective. That is because it is simple. The Treasury will continue to purchase Fannie & Freddie mortgage backed securities and increase their portfolios. The fact that the government is buying mortgage backed securities is keeping mortgage rates low. That is great for those that can refinance. It is really great for first time homebuyers that can now finally afford to by a home because of the devaluation that has occurred.

Meanwhile, I will continue to pay my mortgage on a timely basis. I even have one of those evil adjustable rate mortgages. My rate is lower than any fixed rate you can get now, and it is scheduled to go down again in a couple of months. An adjustable rate mortgage doesn't seem nearly as "evil" as the government taking my money to pay down someone else's mortgage.


  1. I've always admired you and your family for having some financial savvy, and it disheartens me to see that you're stuck with having to rescue others who weren't so wise. My wife and I were tempted a few years ago to apply for a sub-prime mortgage but I hesitated because it seemed so shady. We had also looked at buying a tiny duplex in Burbank at the peak of the housing market because we were being pressured by our families to settle down with the kids. We passed on that opportunity because the though of spending nearly $800K for a duplex seemed outrageous. I stuck with paying rent (and still do today) because I didn't want someone else to pay if I screwed up. It's too bad so many people didn't have this kind of common sense and left others holding the bag.

  2. Thanks for the comment MeanGman. You were wise to follow your instincts by passing on the opportunity to buy property, especially with subprime debt. It seems so obvious to everyone now, but at the time "everyone was doing it" and most people followed the pack. Kudos to you. Now you actually do have a great opportunity to purchase property at an affordable price. If you are thinking about it, don't rush. There is plenty to choose from, and prices won't be rising any time soon.