Will The Housing Bailout Work?

It seems that the new housing bailout being proposed by the administration may not go to the core of the issue, namely helping to stabilize the markets in parts of California and Florida where some of the biggest hits to housing have happened and many problem mortgages exists.

The first approach being proposed, a loan modification, may help some people, especially those whose interest rates have risen considerably or who have suffered a drop in income. The loan servicer can be approached to see if the terms can be adjusted, either by rate reduction or loan term extension. Federal government support provides principle reductions extending up to five years if the borrower stays current. This can amount to $1000 a year. The adjustment lasts for five years after which rates can adjust back up to conforming rates at the time of the adjustment and at most increase by 1% a year. This means there is already an assumption that house prices will have had time to recover or the borrower’s situation improved by that time. We may just be deferring a problem five years out at considerable cost. Another issue is that homeowners may have a second mortgage, which they may have taken to get into the home in the first place or they later added which may complicate things.

The refinance approach may hit a hurdle on a chunk of the California and Florida mortgages as well. To be eligible the mortgage needs to be held by Fannie Mae or Freddie Mac. In this situation if the borrower can pay the new loan amount a refinance may be offered via these institutions. They must have less than 20% equity in their home and loans worth up to 105% of a home’s value may be eligible. Those people with more that 20% equity in their home can refinance though the standard market. The issue is some of the loans in these states were jumbo loans and so won’t qualify, or had low deposits so may not have been Fannie or Freddie loans. Many people who could get Fannie or Freddie loans in these states may have had large equity amounts, down payments, or got into the market long enough ago to still have adequate equity. In addition some people in these states are far more than 5% underwater with their mortgage, which means a modification if viable is the only option.

The one thing not noted is the case of the person with more than 20% equity. If they resisted the temptation to over borrow or refinance money out of the home and have saved money for a rainy day, there is nothing for them if they suffer a drop in income. If the income drop because of the recession is too great to get a regular refinance they have to wait until their finances are depleted for a modification.

A lot of government money is going to go into these programs. If they can’t break the cycle of foreclosures in California and Florida, or stabilize house prices in these states, then they may not do much to put a floor under the issues in the financial markets, or restore house price statistics at the national level appropriately.