The Housing Chronicles Blog: Just how politically motivated is the mortgage-rate freeze idea?

Tuesday, December 4, 2007

Just how politically motivated is the mortgage-rate freeze idea?

With 'Super Duper Tuesday' just about two months away, it's not surprising to see the likes of California's Governor or the Bush Administration weigh in on SubprimeForeclosureGate, but now it's apparently issue #1 at the Hillary Rodman Clinton campaign. In a somewhat threat-laden letter to Secretary Henry Paulson, the Democratic front-runner spells out her demands to put an immediate end to sub-prime foreclosures. Should he not heed these demands (what is she, on a star ship?), then he can expect her to do the following:

I will consider legislation that enables lenders to convert unworkable mortgages into stable, affordable loans without the permission of investors. Protection from lawsuits will remove the obstacle that keeps lenders, servicers and others from turning mortgages that were designed to fail into mortgages families can afford. Right now, servicers who process monthly loan payments and interface with homeowners have flexibility to modify loans. However, they are reluctant to fully exercise this discretion in part because they fear investor lawsuits. Investors who own the securities into which the mortgages have been packaged may assert that they are harmed when servicers help at-risk borrowers. Protection from lawsuits could enable the servicers to help homeowners avoid foreclosures, help investors avoid the losses they would otherwise suffer, and help the economy.

In other words, the first presumption is that all of these loans were made by unscrupulous lenders to victimized homebuyers, with the proceeds split into pieces (or 'tranches' in fancy Wall Street parlance, which means 'slice' in French) to be sold to investors who were apparently also in on the game. I can see the campaign literature now: "Too bad investors -- you have no say in this idea, and you'll take what we give you -- and you'll like it!"

At first mortgage investors hated Paulson's plan, which was to freeze rates for a shorter period of time, but they're now warming up to it because the Democratic alternative is so much more Manichean.

The second presumption is that the 'teaser' rates were set so low that refusing it would be akin to a five-year-old refusing free (and unsupervised) Halloween candy, but it's not that simple, either. According to the a recent AP story, "FDIC officials note that many subprime borrowers received starter rates that were not especially low at the time: typically around 7 percent to 9 percent, when rates as low as 5 percent were common for borrowers with strong credit."

In other words, many of these folks simply bought more home than they could afford and would have greatly benefited from (a) cleaning up their credit to qualify for a better loan; and (b) saving up a down payment to quality for a fixed-rate, 30-year loan. But when the news headlines are blaring huge price increases, it's easy to see that many thought, "If I don't buy now with WHATEVER MEANS POSSIBLE then I may lose the opportunity forever." That's exactly what happened in the last boom-and-bust cycle of the late 1980s-early 1990s.

But who, exactly, would benefit under Paulson's plan? Those already in foreclosure? Nope. Like the "Soup Nazi" made famous in numerous Seinfeld episodes, there will be not be soup (aka mortgage rate assistance) for everyone! According to this Money Magazine article, "Paulson divided subprime borrowers into four groups. The plan would be most geared toward those who can afford the mortgage now but won't be able to after the adjustment. The other three groups are largely left out: Borrowers who can afford an adjustment; those who are already behind on their payments; and those who can refinance into a fixed-rate loan."

And what about the investors and flippers who thought that praying would save them? Looks like they'll have to go soup-less too: "It has also been reported that homes that were bought as investments - as opposed to for the purpose of living in - would be excluded. More than 50% of the increase in delinquent mortgages are actually investor-related, said Wachovia senior economist Mark Vitner. 'It's hard to conceive how many people are actually going to meet this criteria. There's nothing at all in there that addresses investors,' said Vitner, who added he doesn't support an investor bailout."

Ok, so for those who do qualify, how do we decide who can and can't afford their mortgage? Why your friendly, customer-centric mortgage servicer, of course! According to a article:

There are two basic ways to determine affordability. The company that services your loan may use one or both in combination.

The first is debt-to-income ratio. So, for instance, a monthly mortgage payment (including interest and taxes) may be deemed affordable if it does not exceed 36 percent of the borrower's gross monthly income and if total debt payments do not exceed 45 percent of income.

Some lenders making loan adjustments, however, will allow total debt to run as high as 55 percent of income, Shea said.

The second method is documenting an affordability budget. To see how much a borrower can afford to pay for housing, a servicer will compare a borrower's net income to his expenses plus required debts, said Bruce Marks, founder and CEO of the Neighborhood Assistance Corporation of America (NACA).

But servicers differ in what they consider to be "reasonable" to spend on necessities such as food or on non-recurring expenses such as an unexpected car repair. They also differ on what they consider to be "required" debt. So some servicers may consider a second mortgage, a car loan or a credit card balance as debt you need to pay off, thereby reducing the amount you have left to pay your primary mortgage, but others may not.

Servicers may use a cost-of-living index to determine if the amount a homeowner spends on food, transportation and other necessities is deemed "reasonable" but they don't all use the same index, and not all indexes are adjusted for family size or geography.

Clear as mud? Great!

I've never been a big fan of mortgage servicers, which is why I opt out of loans with impounds for taxes and insurance. Each year, there was a hefty surprise: either I got to write a large check right around the holidays, or I got a nice refund check. While the refund check was nice, how hard is it to calculate annual taxes and insurance? Rocket science is it not.

While it's important to address this issue, making it a political contest of "who's doing more for the victimized homeowners?" right before a Presidential election could mean a plan that sounds great but ultimately does little to fix the very simple issue of people buying more home than they could afford and the smiling list of enablers who made it happen.

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