Overburdened Homeowner Subsidized
Home Sweet Home?
Loan modification programs have been seen as the answer to preventing foreclosures and allowing the housing market to stabilize. The programs have become progressively more aggressive as foreclosures continue to mount and housing prices continue to slide. The current government program, Making Home Affordable, has a dual approach whereby a homeowner not eligible for refinancing (at loan to values up to 125%) can then attempt to have the mortgage modified to lower payments. Eligibility requirements are quite simple – if the borrower has suffered a hardship (such as reduced income), is having trouble making the payment or simply bought more house than he could afford during the exuberance of the housing mania, relief in the form of lower payments may be available.
Here’s an actual example of a borrower granted mortgage concessions under the US Government’s Making Home Affordable program.
Home owner purchase the home in 2005 for $153,000 with a stated income mortgage, 100% financing.
Home owner refinanced a year later and received $30,000 cash with a stated income $190,000 mortgage at 7.125%. The home is now worth about $165,000.
Home owner works at a grocery chain and earns $43,000 with limited prospects for increased income. Credit card debt amounts to $22,000 with monthly payments of $315.
Home owner’s current housing expense and other debt payments result in front end and back end debt ratios of 46/55. A back end debt ratio is calculated by dividing borrower’s total mortgage payment, taxes, insurance and all other minimum monthly debt payments divided by gross income. After debt payments and payroll taxes, home owner is left with about $950 per month to cover all other expenses. Home owner is 45 years old, has minimal savings and a negative net worth of around $50,000.
Home owner is not eligible for the Making Home Affordable refinance program since the debt ratios would still be too high even with a rate reduction to the current prevailing mid 5% mortgage rate.
Homeowner therefore applies for a mortgage modification. The basic requirements are that you are having trouble paying your mortgage and your front end debt ratio exceeds 31%. The front end debt ratio is the monthly mortgage payment, taxes and insurance divided by gross monthly income. Homeowner is approved for a mortgage modification that lowers the rate to 2% fixed for two years, with an increase to 3% in year three, 4% in year four and then fixed in year five at the prevailing conforming rate. No principal reduction of the loan was granted. The initial rate reduction lower the home owners debt ratios to 31/40, a ratio that should allow debt payments to be handled without undue stress.
Comments – Who Won and Who Lost?
If the homeowner decides to sell the home, $30,000 cash would be required at closing due to negative equity, commissions due, etc. Since the homeowner has no cash, a sale of the home would have to be a short sale, with the mortgage holder (or taxpayer) taking the loss.
The homeowner in this case received a mortgage rate that is unavailable to the best A+ borrower. In addition, there were no closing costs to receive the 2% rate. The average homeowner pays thousands in closing costs on a refinance.
The taxpayer winds up paying, one way or the other, for the cost of the mortgage subsidy.
The subsidized 31% debt ratio puts the loan modification homeowner in a vastly better off position than millions of other homeowners with much higher housing debt ratios who are unable to get a loan modification or a refinance.
The homeowner cited would never have been a homeowner if not for the 100% financing, no income verification programs that prevailed during the housing/mortgage bubble years.
Not everyone was victimized by the liar loans and sub prime lenders. The homeowner in this example has nothing to complain about. Besides the $30,000 cash received on the refinance and a zero investment in the property, the homeowner also has a super low 2% government subsidized mortgage rate .
As property values continue to decline, expect ever more costly, aggressive and futile government efforts to reflate the burst Humpty/Dumpty housing bubble.