Ever since the credit crisis began, a lot of blame has been heaped on adjustable-rate mortgages, home loans that recalibrate according to market fluctuations. One brand of these innovative mortgages that have come under special criticism has been so-called “exploding A.R.M.’s” that lured borrowers with unusually low teaser rates that then reset skyward a few years later. These have often been derided as predatory, and lenders who offered them accused of luring homeowners into buying homes they couldn’t afford for the long-term.
Critics of these might want to check out the Homeowner stabilisation Plan put forward by the Obama administration today. The plan would reduce mortgage payments and interest rates for homeowners who have seen their payments rise to more than 38% of their monthly income. But those reductions last just five years, after which they begin to reset to higher rates. In short, Obama is just drawing out the teaser rates a bit longer.
During the next five years, the stabilisation Plan will encourage lenders to lower loan payment below 38% of the owners’ income and provide subsidies for banks that lower the payments to 31%. The actual rate of payment will be even lower, since the government will also pay homeowners with the reduced rates $1000 a year to stay current on their payments.
After five years however, those government sponsored adjustable-rate mortgages will reset. The Obama adminstration promises they will reset at a moderate phased in level. But the loss of both the subsidy and the $1000 payment will automatically make the monthly payments much more expensive. What’s more, many market watchers expect interest rates will be much higher five years from now, putting additional pressure on mortgage rates. We could, in short, simply be prolonging the housing crisis.
Now if you expect that the housing market will quickly recover, you can argue that homeowners who cannot afford to make payment once the subsidies are gone will be able to sell their homes. This, of course, is precisely the bet that the old, bad-ARM lenders made. But now that it’s the government making this bet, we suppose we can all breathe easy.
One other aspect of the bad old mortgage practices was the fact that banks made loans with high loan-to-value ratios. LTV measures the amount of equity put into a house by a buyer versus the loan made by the bank. Loans with high LTVs–meaning, the buyer put little money down and borrowed a lot–tend to default at higher rates.
So, yeah. Obama didn’t want to leave out the LTV aspect of the bad-lending becomes good-lending program. The stabilisation Program will be available to mortgages that have upside down LTVs, with mortgages worth more than the value of the home and regardless of equity contributions by owners.
Check out Family C in the Treasury Department’s Q&A on the plan.
Support Under the Homeowner Affordability and Stability Plan: Three Cases
Family A: Access to Refinancing
- In 2006: Family A took a 30-year fixed rate mortgage of $207,000 on a house worth $260,000 at the time. (The family put just over 20% down.) They received a Fannie Mae conforming loan with an interest rate of 6.50%.
- Today: Family A has about $200,000 remaining on their mortgage but their home value has fallen 15 per cent to $221,000. Their “loan-to-value” ratio is now 90%, making them ineligible for a Fannie Mae refinancing.
- Their “loan-to-value” ratio is now 90%, making them ineligible for a Fannie Mae refinancing.
- Under the Refinancing Plan: Family A can refinance to a rate of 5.16%. This would reduce their annual payments by nearly $2,350.
$196 per month, $2,347 per year
Family B: Access to Refinancing
- In 2006: Family B took a 30-year fixed rate mortgage of $350,000 on a house worth $475,000 at the time. (The family put just over 26% down.) They received a Fannie Mae conforming loan with an interest rate of 6.50%.
- Today: Family B has about $337,460 remaining on their mortgage but their home value has fallen to $400,000. Their “loan-to-value” ratio is now 84%, making them ineligible for a Fannie Mae refinancing.
- Their “loan-to-value” ratio is now 84%, making them ineligible for a Fannie Mae refinancing.
- Under the Refinancing Plan: Family B can refinance to a rate of 5.16%. This would reduce their annual payments by nearly $4,000.
$331 per month, $3,968 per year
Family C: Eligible for Homeowner Stability Initiative
- In 2006: Family C took out a 30-year subprime mortgage of $220,000, on a house worth $230,000 at the time (they put less than 5% down). Their mortgage broker � mum & Pop Mortgage � sold their loan to Investment Bank. The interest rate on their mortgage is 7.5%.
� Today: Family C has $214,016 remaining on their mortgage but their home value has fallen -18% to $189,000. Also, in November, one parent in Family C was moved from full-time to part-time work, causing a significant negative shock to their income.
- Their loan is now 113% the value of their home, making them “underwater” and unable to sell their house. Meanwhile, their monthly mortgage payment is $1,538 and their monthly income has fallen to $3,650, meaning the ratio of their monthly mortgage debt to income is 42%.
- Their loan is now 113% the value of their home, making them “underwater” and unable to sell their house.
- Meanwhile, their monthly mortgage payment is $1,538 and their monthly income has fallen to $3,650, meaning the ratio of their monthly mortgage debt to income is 42%.
- Under the Homeowner Stability Initiative: Family C can get a government sponsored modification that � for five years � will reduce their mortgage payment by $406 a month. After those five years, Family C’s mortgage payment will adjust upward at a moderate, phased-in level.
$406 per month, $4,870 per year
Homeowner Stability Initiative: How the Program Works for the Lender, Government and Borrower
- First, Investment Bank (working through a mortgage servicer) reduces the interest rate so that the Family C’s monthly debt-to-income ratio drops from 42% to 38%. This means that Investment Bank must reduce the interest rate from 7.50% to 6.38%, bringing down Family C’s monthly payment from $1,538 to $1,387.
- Second, the government and Investment Bank share the cost of further reducing the interest rate so that the Family C’s monthly debt-to-income level is lowered to 31%. Any dollar the bank spends is matched by the government. At this stage, Family C’s interest rate is reduced from 6.41% to 4.43%. In total, Family C’s monthly payment has fallen from $1,538 to $1,132.
- If Family C remains current on their payments, they will receive incentive payments up to $1,000 a year, or $5,000 over five years, that would go towards reducing the principal they owe. Additionally, the mortgage servicer can earn an up-front incentive fee of $1,000, plus up to $1,000 per year in “Pay for Success” fees for three years, so long as Family C remains current.