Wednesday, March 4, 2009

The "Housing Rescue" by the numbers

The Obama administration released the details of the housing rescue today, and the WSJ put together a nice "Fact Sheet" that I just reviewed.

Here's the money reward if you purchased a home you could not afford, or were a lender that eschewed the standard practice of lending to credit-worth people:

Servicers that modify loans according to the guidelines will receive an up-front fee of $1,000 for each modification, plus “pay for success” fees on still-performing loans of $1,000 per year.

Homeowners who make their payments on time are eligible for up to $1,000 of principal reduction payments each year for up to five years.
Here's what it means:
  • Borrowers will be given a $5000 as reward for paying their refinanced mortgages on time. The rest of us just get to continue living in the house we bought.
  • Lenders will be given $6000 for modifying a loan that otherwise would have defaulted.
Gee... thanks...

Using the mortgage calculator on, suppose a $300,000 mortgage balance paid over 25 years at 8% interest, which assumes the new interest rate after the initial 5-year period adjustment of a 30-year, 5-year ARM mortgage contract. The monthly payment comes to $2315/month (not including taxes, insurance, and other monthly fees included in the monthly housing payment.)

Now, assume that a refinanced rate of 4.5% for the life of the loan. The new monthly payment drops to $1667/month - a difference of $648/month, or $7778/year. Keep in mind that both the borrower and the lender can each earn $1000/year, reducing the lender's "loss" to $6778 and subsidizing about 5% of the borrowers total annual payments for the initial five-year period. I say "loss" because this is a net gain for the lender versus the borrower defaulting completely on the loan.

Here's the good news that I can see from this program. Will this make a difference for most people that aren’t able to make their mortgage payments at the $2315/month? What's the elasticity of the borrower's willingness or ability to pay based on the 27% reduction? I'm guessing that these borrowers that will refinance are likely to miss at least one payment each year, even at the lower modified monthly payment amount. So the offer becomes void (until Congress inserts some exception to the rule... "You get points for trying...)

It probably will make a difference for some people who have had their hours cut at work or have lost a part-time job that was supplementing income. But for rest, I suspect that making mortgage payments was likely a binary condition - either you're paying or you're not. And if you're not, the 27% reduction isn't going to enable you to make the payments.

What about paying people $5000 and to go into foreclosure instead? Those that can't pay won't, so instead of delaying the inevitable, fast-track the foreclosures, and let the market clear faster so we can get on with the recovery.


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