Our nation is facing the biggest housing crisis in recent history, and the consequences are affecting our entire economy. Today there is much debate surrounding the government’s $700 billion bailout package and what steps need to be taken to stop the bleeding and renew stability in our real estate and financial markets.
Plans on the table so far involve injecting cash into banks, buying up bad loans and possibly suspending foreclosures. These strategies are what I call “quick fixes” or Band-Aids that have little chance of correcting the root problem. Buying bad loans from banks puts the government in the position of having to dispose of a potentially endless supply of bad loans. loans and real estate. A moratorium on foreclosures simply postpones the problem. A growing belief that home loans are high risk will deter lending, allow real estate inventories to build, and push real estate values down even further.
In this article, I propose a simple yet powerful solution to this crisis that provides an opportunity to reverse the downward spiral and create sustainable stability in our real estate markets. But first…
how we got here
Decades of years ago, the only mortgage available to the American homebuyer was a 15- or 30-year fixed-rate mortgage. If the underwriting was successful, the borrower knew what their monthly mortgage payment would be for the next 30 years. The simple formula used to decide what size loan a borrower could afford was based on a specific debt-to-income ratio. If this formula were applied correctly, the borrower would not be able to buy a property that would be beyond his financial means. From a credit perspective, the risk was isolated to personal interruptions in income, such as illness, unemployment, death, etc.
The current problem is a consequence of creative lending practices designed to allow more people to buy high-end homes and leverage the equity in their existing homes to live a lifestyle beyond their means. No one can argue against pursuing the “American Dream” of homeownership. But this dream has now turned into a nightmare because the whole system has abused these creative, greed-fueled mortgages.
The formula for disaster was to combine profit-motivated lenders, mortgage brokers, realtors, and builders with buyers who wanted a better lifestyle, whether they could afford it or not. Although these motivations are not necessarily destructive on their own, when combined with risky mortgages that were issued based on a general overconfidence in a rising housing market and against previous industry fundamentals, it was a recipe for failure. disaster.
Option ARMS, 80/10/10 ARMS, two-year teaser rates, HELOCS, negative amortization loans, and other products allowed people to qualify for mortgages that were up to four times the amount they would previously have been allowed to borrow. The supposed safety net was the assumption that the real estate would continue to increase in value, allowing the borrower to refinance the loan before the unaffordable rate adjustment began. Mortgage brokers further complicated the problem by refinancing existing adjustable loans to new two-year teaser rates (delaying the issue for two more years) and allowing borrowers to get cash back for general living purposes. As long as real estate values kept rising, the music would never stop and there would be no mortgage crisis.
Now, with home borrowers unable to pay, foreclosures flooding the markets, lending has stopped, the housing market is flush with inventory, and prices are down. Qualified buyers are reluctant to buy because credit is tight and no one is sure if the market has bottomed out. Potential homebuyers are holding back, waiting for a sign of a market turnaround, which only extends the cycle down.
Before we see a market recovery, home values will have to bottom out and start to stabilize and rise. Meanwhile, inventory must be reduced and consumed; delinquent borrowers should be bailed out where possible; And to avoid resentment for using taxpayer money to bail out irresponsible lenders and mortgagees, borrowers who are current on their mortgages should be rewarded. A band-aid approach will make the problem worse. We need a solution.
“The Simple Plan”
I call my plan “The Simple Plan.” Creates a one-time 4.5% fixed-rate 30-year home loan insured by the US government for all US citizens age 18 and older using a 90% loan-to-value ratio and strict underwriting guidelines related to income and expenses.
Everyone must be signed up and approved for this new loan. The time allowed to take advantage of this program would be 6 months for existing owners and 12 months for new buyers.
I. Existing Delinquent Borrowers
Under “The Simple Plan,” lenders would make an exception to the 90% loan-to-value ratio and if borrowers can pay off the debt in full at the new rate, they can put their past-due amounts on the back of their new loan and stay in their home. If they are still unable to pay the debt, the servicer would be incentivized to agree to a short sale (possibly to the existing borrower). If the borrower is unwilling or unable to reach an agreement with the servicer, foreclosure would be appropriate.
EXAMPLE 1:
Loan Amount: $150,000
Home Value: $120,000
At an interest rate of 13%, the monthly payment is $1,659.
At an interest rate of 11%, the monthly payment is $1,428.
At an interest rate of 9%, the monthly payment is $1,207.
At an interest rate of 7%, the monthly payment is $998.
At an interest rate of 4.5%, the monthly payment is $760.
EXAMPLE 2:
Loan Amount: $200,000
Home value: $150,000
At an interest rate of 13%, the monthly payment is $2,212.
At an interest rate of 11%, the monthly payment is $1,905.
At an interest rate of 9%, the monthly payment is $1,609.
At an interest rate of 7%, the monthly payment is $1,331.
At an interest rate of 4.5%, the monthly payment is $1,013.
The examples above illustrate projected payments at various percentage rates. In both examples, the loan amount is greater than the value of the home, as is often the case today. Borrowers will typically work to modify a loan by putting late payments and fees on the end of the loan and giving it a fresh start.
For borrowers who do not qualify for full debt but can make payments on a smaller note, the servicer should be encouraged to change the Unpaid Balance (UPB) to a number the borrower can afford. If the manager does not want to modify the UPB, the home would be foreclosed and the manager would assume responsibility for reselling the home at a significantly lower value. Such a scenario would allow many people to stay in their homes and hasten the inevitable demise of unsalvageable loans.
II. existing current borrowers
Under “The Simple Plan,” lenders would give non-delinquent homeowners the opportunity to opt out of ARMs and higher-rate mortgages. Homeowners would have the opportunity to refinance their existing loans at a fixed rate of 4.5%. The 90% loan requirement would be waived. Owners of current loan can modify loan (100%) of debt at 4.5% 30-year fixed rate or borrower can get new loan from another bank at 4.5% 30-year fixed and loans previous ones, a discount of 75% of the 1st and 50% of the second would be paid. The added security of a stronger loan and collateral makes it easier for banks and investors to handle fixed-rate loans. Borrowers would also have the option to find a new lender under these terms.
third party new borrowers
Under “The Simple Plan,” first-time borrowers as well as investors buying rental properties and second homes would be motivated to step aside and start buying homes now. When this happens, the inventory would decrease and the recovery would begin.
New borrowers would be supported with a 10% down payment, a current and accurate appraisal, and an appropriate debt-to-income ratio.
At first glance, it seems that “The Simple Plan” would significantly reduce the monthly income of banks. However, if home values continue to fall and loans fail to recover, most current loans at higher interest rates will end up in default and the downward cycle will continue for the foreseeable future. This plan will allow banks to make more volume and generate substantial income while stability is restored to the real estate market.
Under any other plan, banks may get a higher interest rate for now, but the bottom line will be much worse, and recovery will take years.
“The Simple Plan” is relatively easy to implement and would stimulate the real estate and mortgage markets, revitalize communities, and provide sustainable stability that would benefit everyone.
© 2008 All rights reserved by John C. Begins