Mortgage Modifications

Lots of American homeowners (myself included) purchased property in the past couple of years, on a seemingly neverending tide of increasing home values. As housing prices kept going up and up, getting into the market was a good idea pretty much whenever, because you were bound to see the value rise and you could make a ton of money off of it.

Except when you couldn’t.

Now millions of homeowners (myself included) owe more than their property is worth, and they’re in a real bind. They are essentially stuck in their home and can’t sell it, because they can’t get what it’s worth. (This, incidentally, is why I haven’t yet followed through on my goal of moving to New York City.)

New proposals might give these homeowners a way out… A common suggestion is that banks and other mortgage investors should lower the principle balance owed on the mortgage, so that homeowners will end up only owing what the home is actually worth now. At a glance, that sounds like a great deal for the homeowner, but I’ve got some real concerns about it.

Here’s an overly simplified version of how a bank decides whether or not to give you a mortgage today… You pick out a house for $200,000 and ask the bank for a loan to buy it. They look at your credit history (to see if you pay your debts as promised), verify how much money you make, verify what your bills are, verify how much money the house is worth, and check to see how much of your own money you’re spending on the house (to see how much “skin in the game” you have.) Based on all of that, they figure out how risky the loan is, and decide whether they’re going to give you the loan (and at what interest rate.)

Let’s say you go through all of that, and you get the loan. You are now the proud owner of a home worth $200,000. Three or four years later, the housing market TANKS and the house is only worth $150,000. You’re upset (and rightfully so) because you now owe more on the home than you can sell it for.

Under this new proposal, you raise your hand and cry “Uncle!” and your mortgage balance is reduced to $150,000. You’re happy — you no longer owe more than the home is worth, and you can rest easy at night knowing that you’re not out $50,000.

But who pays for the difference? The bank, after all, shelled out the full $200,000 for the house when you got the loan, and you promised to pay them back. One of two things is going to happen in this scenario:

  1. The bank is going to have to “eat” the difference, meaning they just lost fifty grand on the mortgage
  2. The government will pay the difference, in what amounts to millions of relatively small “bail-outs” of homeowners

Either way, not your problem, right?

WRONG — either way, the community at large ends up paying for it.

If the banks are eating those losses, they’re going to raise interest rates across the board for everyone who wants to get a mortgage in the future. After all, they’ve got to hedge their bets against the possibility that it might one day be worth less and you might need the principle reduced. That, or we go back to the old days of requiring a huge amount of savings before you can buy a house, because you’ve got to put in a massive chunk of your own money to make the bank comfortable that they won’t lose money on the loan.

And if the government pays for it to keep the banks from losing their shirts, then you’re talking about tax dollars “bailing out” people who made arguably irresponsible home purchases… And taxpaying citizens end up footing the bill for their overeager neighbors.

I think mortgage modifications are a bad idea, period. They reward risky behavior, and they take all of the possible down side out of the equation. And I can say this with complete sympathy for distressed homeowners, ’cause like I said, I owe a lot more on my property than it’s worth – it was foolish of me to buy my current home, as it was way more expensive than I could reasonably afford on my own, but I naively did it anyway thinking that the investment would be worth it. Now I have to suffer the consequences, and wait it out.

Having said all of this, if I’m offered my own private “bail out” in the form of a mortgage modification, I’ll jump all over the opportunity. Principled stances are all well and good, but I’m not going to say no. Sign me up!

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4 Responses to Mortgage Modifications

  1. Jennifer says:

    I read an article the other day that talked about strategic foreclosures – where people that are upside down on their mortgages drastically just walk away from it. It amazes me that there aren’t more – punishments I guess for that kind of action.

  2. gatoruptown says:

    It still bangs up your credit pretty badly — definitely not a free pass.

    ALTHOUGH lenders will sometimes agree to a “cash for keys” program in which they’ll actually give you money if you voluntarily walk away, leave the home in good condition, and don’t make them drag you through a foreclosure. Since foreclosures can take FOREVER and are very expensive to the lender, it saves them a lot of time and money.

    Still hurts your credit though, but at least you don’t have months and months of no-payment showing.

  3. Gray says:

    After 6 months of waiting, my traditional mod came through. I have to correct you on one item–there was no government money explicitly involved. In my case, the modification basically lowers the interest rate–over 3 years but the amount owed actually INCREASED-as did the length of the loan.

    I was ready to proceed with the deed-in-lieu of foreclosure (cash for keys) when my traditional mod came through.

    Also, since I was unemployed for 9 months I entered into a forbearance–paying half the payment for a number of months. HOWEVER, I was reported late every month because the full payment was not paid. I essentially have the equivalent of a foreclosure on my credit report–which made the deed-in lieu attractive, especially since I don’t even live in that town any longer! 🙂

    Turns out I kept the condo and have a renter–who pays about $700/month less than what I owe monthly. Ain’t homeownership grand!

  4. […] Chase vs. Mortgage Modifications In a recent blog entry, I shared my own little rant on the subject of mortgage modifications — one of many proposals to help rescue distressed homeowners whose mortgage payments are […]

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