Tuesday, October 14, 2008

Examining McCain's Mortgage Plan

It's been a week since McCain shocked conservatives during the last debate by announcing his plan for the government to buy mortgages of homes facing foreclosure and renegotiate those loans to a level borrowers can afford. It is McCain's belief that stabilization of home values is the key factor to turning the US economy around.

To do this, John McCain will have the government buy the failing mortgages at a dollar to dollar cost. So if a loan was issued for $200,000, the federal government will pay the lender $200,000. This act will remove the devaluing asset from the lender's books and free up cash for the lender to make new, more sound loans.

The government will then renegotiate a new interest and principal with the home owner that will allow them to make their payments and stay in their home. This will have the added value of keeping the supply of available homes to a minimum, which should help housing values of homes currently on the market.

Because the home owner will now be able to make their payments, the interest the federal government will receive from the loan will ultimately net the fed a small profit. Let's take a look at how this might work.


Borrower A took out a $200,000 loan on a 30 year, adjustable rate, interest only loan with no down payment. The interest on this loan was fixed for the first 5 years. Their monthly payment was $830 plus insurance.

They successfully made this payment until their loan left the fixed rate period, at which time the interest rate jumped to 11%.

Because the borrower's home depreciated in value, they were unable to refinance into a fixed rate mortgage. At 11% plus principle now being factored in, their monthly payment ballooned to $1923 plus insurance.

Suddenly, they were unable to make the payments.

The government steps in and purchases the loan from the bank for $200,000. They contact the borrower and renegotiate the loan so their payments would return to the $830 level, where they were able to successfully make the payments.

The renegotiated mortgage will now be for $160,000 at 5% fixed interest over a 30 year term. The payment for the homeowner is now $858 plus insurance.

The home owner can once again afford to make their payments.

Over the 30 year term, the federal government will take in approximately $309,209. That's a profit of more than $109,000.

There are drawbacks of course. First, the borrower might still have problems paying and ultimately, the house will go back into foreclosure. Since a program like this has never been done before, there is no reliable way to accurately forecast the level of foreclosures that still might occur.

The new renegotiated depreciated principle will have the negative affect of driving home values down for the homes around it. It is believed though, that this depreciation would be less than if the home was foreclosed on and sat vacant.

There is also the very real likelihood that the home owners will move and not remain in the home for the life of their loan. The average homeowner moves every five years. Those that do opt to move are bound to result in a loss for the federal government.

Despite the negatives, McCain and his advisers believe the plan will ultimately result in a small net profit for the federal government, have the affect of stabilizing home values, and free up capital to fund credit markets. It's an interesting plan, but one has to wonder why lenders could not simply make similar renegotiations available for their borrowers and not have to rely on the federal government to rescue them from their own bad lending practices.


Anonymous said...

I would not agree to this until I was convinced illegals would not get the bailout. If there really are tens of thousands, if not millions, of illegal aliens with mortgages, I would definitely want to be sure they were not receiving this benefit.

James said...

That certainly is a valid concern. But let me ask you this. Which would you rather have. A home an illegal immigrant bought through a subprime, be renegotiated and eventually paid off or a home bought by an illegal immigrant that gets foreclosed and sits empty for a year or more?