The Case for Homeowner Debt Relief

Today's New York Times reports that nearly a quarter of Americans with mortgages owe more than their home's current value.  One example cited in the story is a homeowner with a $630,000 mortgage from 2005 on a home now worth $420,000.  His interest-only mortgage, once the initial period ends, will require monthly payments of $12,000.  On the other hand, a fixed-rate amortizing 30-year mortgage at 6% for the $420,000 actual home value would require payments of $2,500 (plus taxes and insurance.)  Dropping the rate temporarily to 3% could bring the payment down to $1,800, in the event of a bona fide hardship. 

Or, the lender could foreclose.  It would then incur additional interest advances and foreclosure costs or $20,000 to $30,000 or so while holding the property, and perhaps sell it for $350,000 to $400,000 next year, resulting in a loss to investors (that's us) of $250,000 to $310,000, not to mention a loss of all future interest.

Servicers could provide homeowners an incentive to make payments, and hedge against possible return of home price growth, by offering a principal writedown after 12 months of on-time payments, and linking it to a second mortgage for the difference between the old and the modified mortgage.  The second mortgage should be progressively reduced over five years, to provide equity build-up if home prices do not come back to 2005 levels.  Let's swap homeowner debt for equity, just as we have been doing with banks.

Comments

[Scott]

Nice blog, keep up the good work and feel free to check out mine.

Regards - Scott.

[Hope to Homeowners]

There is a solution for many homeowners that are upside down on their mortgage. The hope 4 homeowners program was introduced and lenders are now ready to forgive large amounts of balances. The FHA is handling much of the logistics for this program and it is just one piece to the puzzle. There are still many pieces that need to be put in place but this is certainly the right direction to start.