A Closer Look At Obama’s Foreclosure Plan

The more you look at the Obama foreclosure remediation plan the more you get that queasy feeling. Not the cost so much but just the sense that they really haven’t thought this through. Let me give you an example.

According to what we know right now, anyone with a Fannie or Freddie loan will be allowed to refinance so long as the value of the house doesn’t exceed 105% of the new loan. The goal is to get the interest rate down to a level that produces an acceptable level. But for now we’re just going to concentrate on the potential inequity inherent in this little corner of the plan.

Consider Neighbor A and Neighbor B. Both own the same tract home that they bought for $200,000 five years ago. Both put down 5% but A borrowed 95% of the purchase price – $180,500- and has mortgage insurance covering the amount above 80%. Home owner B borrowed 80% or $152,000 and took out a purchase money second mortgage or a HELOC for the balance – $28,500. So borrowers A and B owe exactly the same amount of money on their homes. The loans just happen to have been structured differently.

Now, for purposes of making the math simple, assume that both loans have had no appreciative amortization of principal (not far from reality for a 30 year mortgage). Both are struggling and prices have declined 25% so that now both houses are worth $150,000.

Based on the announced parameters for the program, Borrower A is out of luck as his mortgage exceeds 105% of the value of the home. Borrower B, however, is home free as his first mortgage – $152,000 – is well within the limit. Borrower B only has to worry about the second lien holder agreeing to the refinance. But why wouldn’t they? As things stand they have nothing so go with the flow and hope prices eventually bail you out.

Two homeowners, the same basic circumstances surrounding their purchase just a difference in loan structure, Do you want to convince A that equity has been achieved?

It could get worse but we have to see the details first. For instance, there was no talk about FICO scores or credit quality in the released details. Many borrowers have discovered that if they don’t pay their second mortgage on a badly underwater house there is little the junior lien holder can do about it. Even if you require that they be current on the second at the point of refinance what prevents them from defaulting thereafter. Nothing has changed. The holder of the second has not seen his interest improved at all. It’s a game waiting to be played.

I don’t want to pick this thing apart but I really am beginning to think that it’s a fool’s errand. Far better for government to concentrate on people and not assets. Let the foreclosure nightmare run its course. In the end we arrive at a housing market that is much more reasonably priced for the next generation. In the meantime, direct all of that money towards putting those who are losing their property back on the road to a new life.

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