Comparing Upside Down Homeowners to Bankrupt Companies

On July 1, 2009 the FHFA announced that they were increasing the maximum LTV on agency held refinances from 105% to 125%.

This new guideline applies only to existing FNMA/FHLMC mortgages. As before, it does not allow cashout, or to payoff second mortgages or any other debts.

Many financial experts are up in arms over this latest announcement, but I don’t understand their concerns.

To address their concerns, let’s compare a company filing for reorganization under bankruptcy protection to a homeowner looking to lower their payment via a refinance or loan modification instead of getting foreclosed on.

Under Chapter 11 bankruptcy, a company gets to negotiate with its creditors to try to stay in business. Creditors renegotiate because getting something is better than getting nothing.

If the business doesn’t have enough cashflow, its creditors can try to force liquidation to recover what they can. Often though, working out a reduction in debt is better for all and the company eventually emerges from bankruptcy protection.

How do businesses get themselves into a bankruptcy situation? Either by losing a major lawsuit, taking on too much debt, declining business due to adverse market conditions or through some combination of these.

Now let’s look at an average distressed homeowner. Most of them got into their distressed situation by taking on too much mortgage debt, choosing too aggressive of a mortgage program that’s resulted in a significant payment increase and through the bursting of the housing bubble.

Most still have jobs, so they have cashflow. They just have payments they can no longer afford.

Companies are forced to file for bankruptcy when their debt payments are too high also. Lear just announced they’re filing for bankruptcy protection after they missed a scheduled debt payment last month. They also announced they’re already in discussion with their creditors to lower their debt obligations.

If companies are allowed to file for bankruptcy protection and renegotiate with their creditors to lower debt payments, why all the fuss about allowing homeowners to do something similar?

Let’s circle back to this latest announcement about allowing refinancing up to 125% of a property’s current value.

Who picked this 125% figure? What's its significance? What data backs it up? Who cares?

It doesn’t matter as the government already owns FNMA/FHLMC and so, has basically guaranteed over half the mortgage debt in this country.

By allowing homeowners to lower their interest rates & thereby their house payments, fewer people will default on their mortgages. How is that a bad thing?

Numerous statistics show that a lender losses more through a foreclosure than renegotiation.

Now many financial experts will argue that upside down homeowners will choose to walk-away from their mortgage debt rather than throw good money after bad.

Don't ever underestimate the emotional factor. People usually love their homes and want to keep them. Their home is not some portfolio of stocks they barely understand and are detached from. They live in their homes everyday and are very emotionally tied to them. Just speak with anyone that’s lost their home to foreclosure to get an idea of the emotional impact.

A logical reason also comes into play. Most homeowners will continue to pay because they have to live somewhere! If the cost of remaining in their current home can be brought down within X% of the local rental market, then they cannot live somewhere else cheaper. So, they will stay and pay, hoping that housing prices will recover and they won't be upside down forever.

The government actually just needs to do away with appraisals on restricted refinances altogether. This has already been the case with FHA Streamline refinances since 1984 and I've never heard any "financial experts" complain about that program.

By the way, these arguments also apply to loan modifications. I’ve heard a lot about the failure rate of modifications, but don’t buy into it. Most of those failure numbers are based on loan modifications that did not follow the government guideline of getting housing payments down to 31% of the borrower’s income. Many were actually forbearance workouts that raised payments to recover default amounts.

So, I throw the challenge out there for other experts to address how this comparison is flawed. Don’t just throw out a half-baked opinion though. Do your research please and present a logical response.

Comments

[Cold Reality:]

The concern is over re-instituting a policy that bears stark resemblance to ones that got us into the home mortgage bust in the first place. That, and the fact that the grant of the ability to finance 125 percent LTV does not comport with the intent of the mortgage workout policy, which by contrast is intended to recast mortgages so that the payments are lower and more manageable.

If F&F policy is not aimed at accomplishing the latter, then it is rightly to be called re-inflating the bubble.

Jul 02 04:37 PM

[daleheiser:]

I own a condo and have an outstanding balance of $140k, consisting of $104k primary and $36k secondary. I took the home equity to consolidate debts. At the time the property was valued at $163k but now it is valued at $134k. I'm looking to sell because i am engaged and will be moving into my fiancee's home. Check obamamortgage2009.blog... If I have a buyer who offers me within say $5-7k of the outstanding, can i agree to assume a loan on the residual and pay the bank the difference over time with interest? The same bank holds both mortgages.

Jul 02 11:32 PM

[howardamin:]

It is estimated that Obama's plan could benefit 8 to 9 million homeowners from the new modification procedures. So how do you know you qualify for the Mortgage Modification? Check the website obamamortgage2009.blog.../
to see if you qualify. I was also in trouble and I am glad I did check it before I talk to my mortgage company and it helped - howardamin, California

Jul 03 02:06 AM

[Loan Survivor:]

Dale - most lenders will consider converting part of your mortgage to a promissary note if you're selling the property. It's not always easy to negotiate, but can be done.

Howard - the 105% program was expanded to 125% because the number of aided homeowners fell well below initial projections.

Jul 03 03:25 PM