Example 1 of AllStreets Bailout in Action: How a Typical Homeowner and Her Mortgage Lender Is Rescued
In 2002 Sara's home was appraised at $250,000 and she refinanced her 7% mortgage at 5.875% with a balance of $200,000 to save on interest costs and to reduce her payments. She didn't take cash out except to pay closing costs. Her new payment is $1,166.43 per month not including real estate taxes or property insurance. Her first mortgage was 80% loan-to-value ("LTV").
In 2005 Sara's home was appraised at $300,000 and she decided to take out a home equity line of credit ("HELOC") second mortgage of $70,000 to add an addition and for other home improvements. With good credit and employment she qualified easily. At that time her total mortgage financing was 90% of the home's market value (90% "CLTV"). She and her lender agreed that 90% financing was pretty safe, and that it was rare for housing values to drop by as much as 10%. They thought that the worst to expect is that values might dip a little bit for a while, but could plateau for several years before going up again. The value would probably keep going up before that even happened. They also thought she might have a good chance to refinance her first mortgage at a rate around 5%, if rates ever got that low (they did, but she didn't do anything and now it's too late for her to be able to do it). As a precaution, Sara only used $65,000 of the credit line. Her interest rate is now 4.25% (prime rate 3.25% plus a margin of 1.00%) on the credit line and her minimum payment is now $230.20 (interest-only), but she's paying more since she's worried what will happen to her payment when the loan coverts to a 15-year amortization at the end of the draw period in 2015. Sara's also worried about how the interest rate might vary over time on the credit line.
The home improvements didn't directly add much value to the home, perhaps $20,000. However, by the end of 2006, the peak of the housing market, Sara's home had an estimated market value of $330,000 according to a realtor and as shown on her 2008 property tax records (value was established as of 1/1/07). Now in January, 2009 her home is estimated to have a market value of only $260,000, a drop of $60,000 (an 18% drop, the national average drop), but her home loans total $265,000 ($5,000 of her credit line wasn't used). She owes $5,000 more in mortgage principal than what her property is worth. So Sara's "upside-down" with her mortgages. She'd like to refinance now to get the 5% rate she once hoped to get, but can't do it now. An 80% LTV conventional first loan would be $208,000, which she could get, if it weren't for the fact that she has a credit line of $70,000 with a balance of $65,000, so her mortgages total more than 100% of her home's value.
Sara doesn't have enough investment funds to pay off the second mortgage, especially since her portfolio value dropped by 50% from it's 2007 mid-summer value, and even if she could pay off enough of the credit line to get her CLTV down to 95% in order to qualify for a conventional loan, the credit line is still $70,000, so her HCLTV is over 100%. In any case, pricing adjustments for a loan at 95% CLTV would not allow a 5% rate without considerable extra discount points in the closing costs. If she could pay down the credit line and get a new second mortgage at 90% CLTV, a good level for rate pricing and closing costs for conventional loans. Unfortunately, second mortgages of 90% CLTV are no longer available (the lending system has been bankrupted mostly by the worthlessness of second mortgages). 85% CLTV is about the highest available for home equity loans and lines of credit, and even those are hard to find. That would mean a second mortgage of only $13,000, so she'd need to pay off $55,000 of her credit line to get it, which isn't feasible for her.
If Sara paid off $18,000, and paid all closing costs on the new first mortgage out of pocket, which she could manage, she could use a 95% LTV loan with mortgage insurance, but the rate wouldn't be much better than 5.75% so it wouldn't save her much on her interest rate or payment. It's the same story with an FHA loan because that has an extra rate of 0.5% added over market rates in order to cover mortgage insurance, plus an up-front, non-refundable mortgage insurance premium that raises closing costs considerably. So that scenario doesn't help her much financially, except to get rid of the HELOC that has an uncertain future.
Sara's second mortgage lender is worried. The balance of her credit line puts her total mortgages $5,000 over what her home is worth. In late 2008 the lender froze the open balance of her credit line, as most HELOC lenders have done with their borrowers' lines. The lender is having financial problems due to the generally elevated level of delinquencies and foreclosures, and the fact that about 25% of all their borrowers now owe more on their properties than the properties are worth. The lender has had to write down the value of Sara's loan and many others since the balances are more than the properties are worth. The situation is increasingly similar with the lender's commercial property borrowers. The lender is not inclined to lend to very many applicants right now, except the safest looking loans to the most highly qualified, even though the lender has obtained some TARP funds to shore up its balance sheet. The only mortgage lending the lender will do are loans that can be sold to Fannie Mae or Freddie Mac or have FHA insurance. The lender doesn't foresee how his upside-down clients are going to get out from under their loans, and is very concerned that many will walk away from their homes or do short sales, if housing prices don't improve in the next few years, or if they are forced to move for some reason. The lender is also worried that many of his clients will have problems with unemployment as the economy deteriorates.
In early 2009 Congress passes The AllStreets Bailout Plan. Sara receives a Housing and Economic Recovery Certificate (HERC) showing her name and her property and a value of $48,000, or 80% of the $60,000 drop in the value of her home from December, 2006 to the date of the law. The HERC entitles her to a government loan equally split between her and her lender to pay down her mortgage, and for no other purpose, since her mortgages total more than $48,000. She submits the certificate to her HELOC lender who submits it to the government to get funds to pay off $48,000 of her line of credit. The government creates two 30-year 3% fixed-rate loans, each $24,000, one to her and the other to her lender, each having a payment of $100.02. She now owes only $17,000 on the line of credit. Her mortgage balances now total $217,000, or only 83.46% of the $260,000 current market value of her home. Her new payment on the HELOC plus the HERC loan total only $160.14, with $100.02 of that now being fixed for 30 years and amortizing, instead of $230.20 interest-only with an uncertain future for the rate or payment.
Because Sara's no longer upside-down on her mortgages, she now has many options with her property. She can either do nothing and continue with her current mortgages, or sell the property and recover some equity, or pay off the HELOC and refinance into a new first mortgage at 80% LTV, if the rate is favorable. Alternatively, she could get a new line of credit at 85% CLTV to pay of the balance of the old line, and still be able to refinance her first mortgage without mortgage insurance, or get one new first mortgage at 85% LTV to refinance both the old first mortgage and the line of credit.
Sara's second mortgage lender is now extremely happy. Her loan is only $17,000 instead of $65,000. She owes much less on her property than it is worth. Since the lender has frozen the line of credit, the balance won't increase and the borrower's overall level of financing on the property is much less risky. The lender now has $48,000 in recovered capital to lend, and only half of that is a government loan, a favorable one at 3% fixed rate for 30-years that provides inexpensive capital to lend or invest. All of the lender's clients who own residential properties have been similarly repaired. The lender's balance sheet now looks great. Since this is happening all over the country, not only have the finances of all lenders and borrowers been much improved, but those who didn't have mortgages are entitled to use the government loans to pay off credit cards, or for second mortgage money to purchase a property, or for business or personal loans. Formerly bankrupt investors in second mortgage securities, and all other mortgage securities, suddenly see them trading in liquid markets again with much improved pricing. The prospect for economic prosperity is excellent and the stock market is rallying big time. the value of Sara's home is now rising.
Posted by The Mortgage News at 1/25/2009 9:51 PM 
Categories: mortgage crisis, Housing Values, Wall Street bailout, TARP funds, AllStreets Bailout Plan, Main Street bailout
Categories: mortgage crisis, Housing Values, Wall Street bailout, TARP funds, AllStreets Bailout Plan, Main Street bailout
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