A sensible route toward principal reduction and real estate recovery

Government programs have largely been focused on helping homeowners avoid foreclosure.  In a real estate market that is flat or worse, many people on the edge of ownership affordability may be better off financially if they became renters.  Recent programs that contribute toward facilitating short sales may help renters in progress make the transition while softening the impact on the market. It will, however, do little if anything to stimulate it.

The market will not reignite until people who are not struggling with maintaining their present home, who can easily make their monthly payments, and who want to move up can actually do it.  Millions of Americans are comfortably making their mortgage payments and desperately want to trade up to a bigger, better, more expensive home.  They are stuck with a home they bought 4, 5, 6 years ago with traditional financing, and they still owe a lot more than the home's current market value.  If our real estate market is going to return, there has to be a way that those folks can again become active participants.

If banks would adjust interest rates, but not payment amounts for, let's say three years, a lot of negative equity homeowners could catch up and re-enter the marketplace.

For example, you bought your home in 2005 for $230,000, with $30,000 down and a $200,000 30 year loan fixed at 6.5%.  After five years, the balance is around $187,000 and the home's market value is about $172,000.  If prices remain flat, it will take you twelve years to get to a level that, after selling expenses, you are back to even.

If the bank reduces the interest rate by half, to 3.25% and the payment remains the same, it would take just three years to get back to even.  That would put the owner close to being able to return to the market and move up. It would increase demand for homes and new financing from high quality borrowers and buyers.  Without a sensible workout plan to accelerate the negative equity in financially stable owners, we will continue to wallow in this stagnant market for the better part of a generation.