One of the continuing mess in the mortgage industry I thought it worth revisiting the topic and some ideas I had on what might be done. Today seemed a fitting day to review such a topic
Because my practice is increasingly focused on bankruptcy and because I live in the epicenter of the meltdown I have seen many of these people sitting across from my desk. Even when I am not at work when the subject comes up people tend to turn to me for my so called ‘expert analysis’. Although I am FAR from an expert I have had occasion to consider what things might be done to resolve the problems and I thought I might offer them for your consideration and comment.
The major issue seems to be what to do when a house that was worth $ 300,000 is suddenly worth only $ 200,000 but still has the full $ 300,000 mortgage hanging over it. Between that and rising interest rates the homeowner has few options to save his home. Often I have spoken with clients who suggest that it might help if the bank reduced the mortgage to the current value of the house, which would both reduce the payment and give them a reason to fight for the property beyond emotions.
Under that scenario, the bank continues receiving monthly payments, but should it absorb the entire loss? The homeowner took the risk and, as one banking friend of mine pointed out, if the house had gone up in value to $ 400,000 it is doubtful the homeowner would share that profit with the bank.
But it is also not in the interest of the bank to have the homeowner go bankrupt and leave them stuck with yet another property that they have little prospect of selling. Such losses simply reduce the housing market further and cause even more problems. The recent collapses have demonstrated what happens when companies see all of their mortgages fail.
So given that both the bank and the homeowner have an interest in keeping the owner in the house I have developed what I think could be the basis for a solution. It is admittedly bare bones and would require much more detail but it might be a first step.
The basic solution would be for the bank and the homeowner to share the loss with the understanding that the bank has the right to make up that loss should the housing market return to old levels.
To illustrate, let us go back to that $ 200,000 house with a $ 300,000 mortgage. There is now a net negative value of $ 100,000 on the house. Splitting that figure in half yields us an amount of $ 50,000 so the bank and the homeowner would agree to reduce the mortgage to $ 250,000.
This way the bank would eat $ 50,000 of the loss while the homeowner would absorb the rest of the amount. The monthly payment would be reduced (in this case) by roughly 17% (or $ 350 a month on a $ 2000 payment). The homeowner would be making smaller payments and could stay in the home.
In exchange for accepting what is basically a $ 50,000 gift to the homeowner the bank would have two benefits. First they could take that loss as a deduction against income on their taxes which would help their bottom line. Second, if the house were to go back up in value the bank could increase the mortgage by up to the $ 50,000 amount they forgave.
So again looking at our example house, if after 5 years the house were to go up $ 50,000 in value and the loan balance (after 5 years of payments) was down to $ 225,000 it would be increased to $ 275,000. The homeowner would now have a $ 300,000 house with a $ 275,000 loan balance which is still $ 25,000 in equity.
If the house did not go up in value then the loan would remain unchanged.
As I said this proposal would require a lot more work to become fully viable. We would need to continue or extend the current federal exemption against the forgiven debt being taxable income (otherwise the homeowner would be in trouble with taxes). We would also need to work something out on interest rates, perhaps extending the current system in place for those in risk of foreclosure to a larger pool of people.
Clearly I am no financial expert nor am I a US Senator (but if there is an opening let me know) so this is far from a complete proposal. But it might be a good start.
Cross posted from The Square Deal