Bailout Information

There is some research that suggests the sub-prime meltdown is only the fist phase of the mortgage industry’s problems.  An article in The Economist magazine points out that there could be another wave of defaults coming because of pending “recasts” on the large number of option ARMs out there.   The option ARMs allowed borrowers to pay less than the interest owed each month, and even allowed an occasional payment to be skipped.  Most who took out these types of loans took full advantage of their choice not to pay, and as a result they now owe more than their original loan amount.  With home prices declining and mortgage balances growing, these homeowners have been squeezed from both sides.

According to the article, the wave of option ARM troubles will begin in early 2010 and peak around the middle of 2011.  So how many homeowners with these loans will be eligible for the bailout?  Based upon the eligibility dates described in my earlier post, only the early part of the wave will be eligible.  This demonstrates the arbitrary nature of the bailout requirements.  Just as the number of option ARM borrowers who are in trouble begins to rise, eligibility for relief will be cutoff in mid 2010.

The more we learn about the refinancing portion of the bailout, it is clear that those who are eligible are getting a great deal.  According to this article at nola.com, those who refinance under the bailout terms will see a significant portion of their mortgage forgiven, and will even gain instant equity in their home:

Homeowners would get a new 30-year fixed-rate loan at a lower interest rate from the FHA. The new mortgage would be 90 percent of the home’s current market value […]”

Not a bad deal considering anyone eligible is certainly upside-down on their current mortgage.  However banks are not required to refinance - the government package just makes it more feasible for them to do so because it will back the new loans.  But it could be quite a fortunate turn for some.

More specifics on the eligibility requirements:  To qualify, the ratio of the mortgage payment to income must be 31%.   For example, a person making $50,000 per year must have a payment higher than $1291 per month.  (To arrive at this number, take the annual income, divide by 12, and multiply this number by 0.31)

Of course there are still questions, such as what number is used for income; e.g. is it based on last year’s tax return or someone’s pay stub?  I also don’t know if the monthly payment value includes tax and insurance impounds, or is just principal and interest on the loan.  I’ll post back when I learn more.

On Wednesday, President Bush signed into law the Foreclosure Prevention Act of 2008 (HR3221), or what is more commonly referred to as the Mortgage Bailout.  The new law is a broad measure targeted at bolstering the general economy by preventing further slides in the housing market.

Among the bill’s many provisions are measures that are intended to help up to 400,000 homeowners at risk of foreclose due to pending “resets” on Adjustable Rate Mortgages (ARMs).  Those who are eligible will be able to replace their existing mortgages with fixed-rate loans, avoiding the sudden increase in monthly payments that are written into the terms of many ARMs.  The new, fixed-rate loans will be provided by existing lenders who previously were not willing to accept the risk of refinancing many homeowners.  The bill allows these lenders to limit their risk on these new loans because they will be guaranteed by the privately owned, but government backed, Fannie Mae and Freddie Mac.

Exactly which homeowners are eligible for relief is not precisely defined, but it is clear that there will be a distinct group who will benefit.   Homeowners who do qualify will get some generous assistance – those who do not qualify will receive nothing.  One component of the eligibility requirements is based upon the specific date that a homeowner got the original loan: to be eligible, a homeowner must have signed on to an ARM between Jan. 1, 2005 and July 31, 2007, and their ARM must be scheduled to reset between Jan. 1, 2008 and July 31, 2010.  In addition to the date ranges, the homeowner must not be behind on payments and must be able to show they cannot afford the new payment after the reset.  This last requirement is vague – how the government will determine who can or cannot afford their payments is the tricky part.

Not surprisingly, there is controversy surrounding this new law.  Although it passed with a strong majority from both the House and Senate, the legislation has many critics.  The main concerns surrounding new law include the sheer cost of the bill, the fact that many homeowners will be excluded, and the argument that it rewards irresponsible behavior by removing the consequences for some who purchased a house they simply could not afford.  Time will tell how the economy will be impacted by the Foreclosure Prevention Act, but the mortgage bailout will certainly have an influence, for better or worse.