The Obama Easy Payment Plan for Irresponsible Homebuyers

The Homeowner Affordability and Stability Plan

On February 18, President Obama announced a $75 million comprehensive plan to help homeowners avoid foreclosure by providing affordable and sustainable mortgage loans. The Homeowner Affordability and Stability Plan has two parts major parts but also contains other minor provisions. One part of this program one may have heard about, the judicial modification as part of a bankruptcy, is not achieved by this act but is simply proposed. Here is what is in the plan.

The first major part of the program provides for a sweeping loan modification program targeted at borrowers who are at risk of foreclosure because their incomes are not sufficient to make their mortgage payments. Some 3 to 4 million homeowners will be helped under this program.

The second part of the program provides refinance opportunities for borrowers who are current on their mortgage payments but have been unable to refinance because their homes have decreased in value. They may now have the opportunity to refinance into a 30 year, fixed rate loans. Fannie Mae and Freddie Mac will allow the refinance of mortgage loans that they hold in their portfolios or that they guarantee in their own mortgage-backed securities. Four to five million people will be helped under this program.

Here are the major components of the Loan modification provision of this program.

• A Shared Effort: If the lender will lower the payment so that the mortgage payment does not exceed 38% or the borrower’s income, then the treasury will match the reductions dollar for dollar down to 31% of the borrower’s income. The interest rate reduction necessary to reach this lower ratio would stay in place for five years then would be stepped back up to the conforming loan rate in place at the time of the modification. Subsidies could bring the interest rate as low as 2%.
• Incentive to servicers: For each loan so modified the servicer will be paid $1000 up front and up to $1000 a each year in “pay for success” fees.
• Incentives for Borrowers: As long as the borrower stays current the borrower will get $1000 a year for up to five years.
• Reach Borrower early: To encourage servicers to help at-risk borrowers before they go into default, an additional fee will be paid servicers and mortgage holders for loans they modify.
• Home Price Decline Reserve Payments: This is an insurance fund to grantee loans so that lenders will be willing to modify more loans in areas where house values are declining.

Here are the major components of the refinance provision of the program.

• Conforming loans. The loans had to be good loans to start with.
• Standard underwriting. The borrower must meet standard credit standards
• Higher Loan to value. The new loan can be up to 105% of the homes value.

Commentary

I do not like this plan. It may work. It may stabilize housing, but it is wrong. We could have done better. I do not have much of a problem with the refinance provision of this act but do not like the loan modification provision. Something had to be done however to slow the rate of foreclosures.

If the house next door to you goes into foreclosures your home value can drop. If several houses on your street go into foreclosure your homes value can drop considerably. Your wealth can be eaten up through no fault of your own. If you need to sell your home, you may have to sell it for considerably less than what you think it is worth. There is a social cost to other people’s foreclosures and we must do something. As long as existing homes are dropping in value lenders are going to be reluctant to ease up on credit and allow even deserving borrower to finance homes. This crisis stated in the housing sector and I do not think we can pull out of the economic crisis until we stabilize the housing market. Nevertheless, I don’t like this plan. We needed to so something else other than what we have been doing, but I think this is the wrong thing to do.

Rather than just give the money away, I would have preferred a plan that placed a second or third mortgage on the home of the borrower that got the assistance. We could have designed a program that made a loan to the borrower in order to “buy-down” the first mortgage. This loan could be a “due on sale” loan so the borrower would not have to pay the loan back as long as they lived in the house. If the home value never increases then the tax payers would still be out, but if home values stabilize and then increase the taxpayer subsidy would be paid back and the irresponsible lender and borrower would not realize a profit due to the government rescue.

Another possible way the bailout of irresponsible lenders and borrowers could have occurred is a “shared equity” loan designed so that if and when property values again accelerate the government recoups any subsidy but in a way that is proportional to the increase in equity. We needed to so something and I could have designed better ways to do it.

Perhaps the simplest way to achieve the desired effect of slowing the foreclosure rate but not enriching the irresponsible is to simply encourage mortgage companies to modify the loans by changing the amortization period to forty years or fifty years or however long it takes to make the payments affordable. The loans could still be 30 years loans but with a balloon at the end of 30 years. The homeowners who benefited by buying housing they cannot afford would still get to live in the houses they should never have purchased in the first place, they simply would not benefit by pocketing the equity and sticking it to the taxpayers.

One thing I do not like about the loan modification provision of this program is that it only helps the irresponsible. I see responsible people who are losing their home every day due to the loss of a job. I would have preferred that some of those people to whom bad things happen be helped and fewer of those who simply bought more house than they can afford. The economic impact would be the same weather we help a person who is facing foreclosure because a spouse died or because they bought too much house. This package does nothing to help the deserving borrower.

One of the most objectionable aspects of this program is paying people $1000 a year for simply making their new lower mortgage payments on time. This is an outrage. All of those people who didn’t buy more house than they should have bought, and who were smart cautious borrowers and who got good loans are not going to be rewarded for paying their house payment on time; the irresponsible will be. If you are a responsible person in today’s world you are a fool. I guess rewarding the irresponsible is the kind of change people voted for in November.

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