A few days ago, I made some comments about the new rate freeze plan based on the details that were out at the time. See Help on the Horizon for Sub-Prime Borrowers? Now that more details are known, I am a lot more skeptical about the positive effect that this plan is supposed to have on our economy.
Voluntary Cooperation
First of all, this is a voluntary plan. I am thankful for that because I believe that the less the government interferes in our lives, the better. However, it makes me wonder why the banks can't just work with people on a one-on-one basis to help prevent financial disaster. This plan calls for them to be approved individually anyway, so to me that makes this whole thing look like more of a political tool than anything else.
Bail-out versus Helping the Needy
There are two sides of this argument. Some claim that this is just bailing out people who made poor financial decisions. Others focus on those who are in this situation because they didn't understand what they were getting into or were victims of predatory lending. The truth probably lies somewhere in the middle and both types of people will be affected by this.
There are always those who are in a bad situation because of circumstances beyond their control or because they were taken advantage of. Most of us would agree that we want to help those people. This is the same reason that so many charities exist and so many of us donate in order to help the less fortunate. However, the law of fairness makes us cry out that we should not be responsible for other people's poor decisions. Why should we all lose our dessert just because Johnny wouldn't eat his dinner???
Let's take a look at the details. This plan is available to those who either have low equity or low credit scores (prohibiting them from refinancing) and to those not currently behind on their payments. So on the surface it looks like we are offering assistance to those who are in a jam (unable to refinance) but who have the integrity to keep up on their payments.
Help For the Economy
But wait a minute!!! This plan was touted as something that would be beneficial to us all. It is supposed to help prevent foreclosures from causing our home prices to plummet. However, those who are currently making their payments on time are not those that are threatened by impending foreclosure. It is those homeowners who are struggling to pay their mortgages who are most likely to be foreclosed on or to try to prevent that by doing a short sale. Under this plan if a homeowner is over 30 days late (an indication of some financial struggle and a possible future foreclosure) he or she is not eligible for assistance. So much for helping the public as a whole! Of course, if the plan did help those who couldn't pay their mortgages, some would cry loudly that we're bailing people out and preventing them from experiencing the consequences of their actions. That would be true in most cases, but at least it could possibly be justified if it helped stabilize our economy as a whole.
Who Pays for this?
Well, we all know the answer to this one is WE DO!! More specifically, the investors who have invested in mortgage backed securities will suffer. An interesting commentary on this is found here: Why the Rate Freeze Won't Warm the Economy. While I am happy that the government is not taxing us to pay for this, I believe that the effects will ripple outward and we will all pay a little with higher mortgage rates in the future. If there is no measurable benefit to the public as a whole, then perhaps this is not the magic bullet it has been advertised as being.
Does this Really Help those who are Eligible?
Even this is debatable. In the ideal situation, you have Mr. and Mrs. Homeowner who bought at the end of the housing boom and are unable to refinance. Unfortunately, they are looking at their monthly payment doubling sometime in the next 6 months. So far, they have been making their payments on time, but they won't be able to continue to do so once their rate increases. Their credit has improved somewhat since they bought the home, but due to some unexpected medical expenses, some other bills went unpaid and their credit scores are 634 and 640. Also, their home is now worth less than what they bought it for so they can't sell it, but they know if they stay there for another 3-5 years, they will have equity because they live in Tucson and the Tucson market doesn't stay down for long. So to avoid foreclosure, they opt to take advantage of this plan.
Sounds good, right? In some cases, yes. But what about homeowners who don't live in Tucson, but who live in other markets that will continue to see a decrease in prices over the next few years? They could end up losing more money by waiting than they would by taking the loss now and moving down into more affordable housing. If that happens in enough areas, this plan will only serve to prolong and deepen the disaster that is currently upon us.
So What Should be Done?
I believe that if you are going to criticize something then you should have an idea about how to better the situation. Here is my idea. I think that banks should come up with a plan to mitigate their damages. It could be similar to the government's plan, although I think that financially they would be better served to focus on those who are having difficulties making payments because their rates have already reset. In this way, they would only offer assistance to those who are truly in need of help and in danger of losing their homes. This would protect the bank's bottom line (fewer REO properties) and would also help increase profits because they would not be freezing rates for those who may be able to make their higher payments once the rate increases. Some borrowers may get a new job or a raise that enables them to cover the increase a year or so from now.
Once the bank has formulated a plan, it should be presented to the investors for approval. They already have to submit short sale applications to the investors. This type of plan should also be presented to the investors along with projections on how this will increase profitability or at least minimize loss. Banks and investors are involved in the agreement for the rate freeze proposed by the government, but I think that it would be more equitable for all if this was done on a smaller scale so that individual portfolios were taken into consideration. One size never fits all!
What are your thoughts on how best to remedy this situation?
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