The Mortgage Freeze Plan—Devil in the DetailsThe Bush Administration announced on December 6, 2007 a plan to freeze for five years the mortgage interest rate on subprime mortgages that are due to adjust to a higher rate in the coming years. This plan applies only to loans taken out between 2005 and this past July 30, for which higher resets are scheduled in 2008 and 2009.
Administration officials have taken great pains to announce that this plan does not cost the taxpayer anything, but it is rumored that there may be a $500 per modified loan charge that will be paid to mortgage servicers by the Federal Office of Thrift Supervision. Homeowners who live in their owned home and have not missed a single payment are eligible to take part in this program, but their participation is not automatic. There appears to be a discretionary element, such that each eligible mortgage will be considered on a case by case basis.
Hence, although more than a million homeowners may be eligible for this program, a much smaller number would actually receive a rate freeze. The Center for Responsible Lending estimates that only some 145,000 homeowners will actually receive a rate freeze. According to Edmund Andrews of the New York Times, each borrower would face tests aimed at weeding out those considered too hopelessly in debt and those who make too much money to justify relief. While these may be criteria, I believe that a key criterion, though not explicitly stated in the plan, will be whether a quick sale or foreclosure sale is profitable at the present time. If the foreclosure sale value of the home (net of costs) is less than the expected value of the future stream of mortgage payments with a five-year freeze, then it is worth it for the mortgage industry to freeze rates temporarily. Future home price appreciation will also be taken into account. Hence, homes whose values have already plummeted significantly in the market are likely to be seen as good targets for this program.
We will have to wait and see how this plan is actually implemented. My prediction is that it will be applied to markets that have seen steep declines in home values. Over-appraisal of home values is as much a culprit (if not greater) as high mortgage rates in the current subprime crisis. Homes that were bought at wildly exaggerated values (still market value, some may argue) are the ones that are now experiencing deep declines in value. Owners of such homes may find themselves accepted by this program. That is, they will be allowed to carry their huge mortgage debt at a frozen rate for the next five years. A rate freeze at current rates is no gift for homeowners when current rates are as high as 9% to 10%.
Reset to PrimeThe Administration has a plan that will give the FHA greater flexibility to offer refinancing to homeowners with good credit histories. Some 300,000 homeowners are expected to benefit from this. A really bold and correct solution to a significant slice of the current subprime crisis would be to reset mortgage rates to prime rates for homeowners that have good enough credit to qualify for prime credit.
The Wall Street Journal reported on December 3, 2007 that based on its study of subprime mortgages, more than half of the borrowers of subprime loans had good enough credit to get a prime loan. In 2005, 55% of subprime mortgages were obtained by homeowners who qualified for prime credit. It appears that these borrowers were had—they were, for a variety of reasons, forced to settle for a high subprime rate. It is only right that their rates be reset to prime rates, preferably with retrospective effect, but at least from here on.
Although lenders will protest such a forced reset, they should be convinced by the government that this is in lieu of legal action against them for duping the borrowers in the first place. Lenders who don’t comply with a reset will have to face lawsuits. That would be sublime justice. Dr. Nandinee K. Kutty is an economist and a policy consultant. She is a co-editor and contributor for a new book Segregation: The Rising Costs for America (Routledge, 2008). Her email address is firstname.lastname@example.org. Her previous op-ed on the subprime meltdown appeared in October 2007 on http://www.opednews.com/articles/opedne_nandinee_071101_how_segmented_financ.htm