Freeze Interest Rates? Bankruptcy to Profit?
On the heels of our discussion about legislation to remove the Phantom Tax associated with short sales, (see my quote in the Washington post on Short Sale) there is also legislation out there to freeze Adjustable Rate Mortgages for homeowners.
I have the following questions, maybe you know the answers:
1) Will it only help those facing foreclosure, or will everyone that locked into a 2% teaser rate get the benefit of a 4-8% reduced rate. On a $300k house, this comes to up to $24,000 in savings per year! The plan calls to help 1.2 Million distressed homeowners.
2) Who pays for this? The banks already have calculated expected earnings based on the rate jumps. Do we expect the banks to just eat it? Or does the government write the banks a check?
3) If a $300,000 house increases in value to $400,000 in 4 years, after the government gave some a $96,000 bailout, will they be allowed to take that $100,000 profit?
What I MIGHT be able to understand is a Minimum Payment Option, but the unpaid balance be paid at the end, when the house is sold (like a minimum payment on an Option Arm).
My understanding of the proposed solution:
- 2005 purchaser pays $300,000 for a home. 100% loan. 4% rate, that adjusts to 7% in 2007.
- 2007, the government (or the bank) covers for the 3% difference ($9,000 a year)
- 2010, if the seller can sell for $330,000, after 3 years of government subsidies totaling $27,000, they PROFIT $30,000
My proposal:
- 2005 purchaser pays $300,000 for a home. 100% loan. 4% rate, that adjusts to 7% in 2007.
- 2007, the government (or the bank) covers for the 3% difference ($9,000 a year)
- 2010, if the seller can sell for $330,000, after 3 years of government subsidies totaling $27,000, the payback the subsidy for a PROFIT of only $3,000
BOTTOM LINE: While a measure like this might help distressed homeowners, I can see many situations where this might result in a near bankrupt homeowner suddenly PROFITING $30,000 from taking out a risky loan. That doesn’t seem right.
– Written by Frank Borges LL0SA- Broker FranklyRealty.com
(please report typos)
- 10
- December
- 2007
Very interesting Frank. This rate freezing proposal has so many negative scenarios attached to it it is mindboggling. I had not thought of this one before. A valid concern for sure.
I can’t see this rate freezing flying, and I do agree that any subsidies need to be paid back if there is equity in the home within a certain time period. I smell another scam.
I’m sorry, I still am not smart enough to understand this program. You have to be current on your mortgage, but have a score under 660? And if their rate is frozen for 5 years, their payment stays the same. But if they have by chance maxed out all of their other credit scores in order to get their score low enough, and if they are on a fixed income, as most Americans are, and the cost of living keeps going up, it seems like a pretty short term fix. How long until gas is $4 a gallon, and commute times double due to the roads becoming more and more clogged? And don’t forget, they probably can not refi due to the slip in the market, so no financial net there. Can they even refi if they are in this program?
Sorry Frank – I don’t mean to hijack your blog. I just don’t get it.
This link suggests the freeze would aim to only help a few people and the government would not be involved. I don’t think there is going to be any “free money” for anyone…
http://www.breitbart.com/article.php?id=D8TC48RG0&show_article=1
Few people? This article says 1.2 Million people
http://money.cnn.com/2007/12/07/real_estate/freeze_fairness.moneymag/index.htm
Frank,
I share your concern…the fed ‘monkeying’ with rates is scary…and are these mortgages assumable!!! Thanks, Fran
Hi Frank, thanks for the post! It will be interesting to see how this all works out. So many things to consider!
Frank, I do not believe that anyone will benefit from a ‘teaser’ rate. The 2% rates you describe are from option-ARMs and many of those in foreclosure were Subprime borrowers (thus elimating option-ARMs). Of those in trouble who did get Option ARMs, are currently paying at 2% and are trouble, I’m not sure how the government is dealing with them. Perhaps they’ll allow a refinance into a fixed-rate? I doubt they’ll allow them to keep that 2% though.
I don’t have a problem with the banks eating it – many were very lenient in their lending and now must swallow their share of the bad result. Part of me wants the government to stay out of this and let things go as they may (lassaiz faire), but the other part is happy that some in distress are being helped. The one thing I’m solid on is that banks don’t get a free ride. Everyone involved (including borrowers) must share in the blame.
Your last question is a good one. I think there should be some profit-sharing with the government. To request all $96k leaves the borrower with almost nothing and makes one wonder if the so-called bailout is even worth it. But a total free ride absolves the borrower of responsibility. Perhaps a 50% levy on the profit enables borrowers to keep some profit and use that going forward and also allows the government to recoup.
tchaka owen, two points:
1) There certainly were teaser rates on sub-prime ARMs.
2) The rate freeze is not an effort to allow borrowers to realize capital gains so much as it is an effort to stabilize the real estate market from a glut of foreclosures that would exacerbate current economic problems, including, but not limited to: defaults on CMOs/CDOs, further price deflation of real property and a general lack of confidence by the capital markets and currency traders in America’s credit worthiness. Afterall, the full faith and credit of the US treasury is all our our currency is worth.
I would like to see some belts and braces put on this program to ensure that those that truly need assitance get the help the need and those that deserve to lie (lay?) in the bed they made do so. Specifically, any borrower seeking relief under this program should be asked to substantiate all information furnished by them to the lender in connection with the loan application and underwriting process. If any information can not be substantiated, the borrower should be disqualified for relief. If any information is found out to be fraudulent, the borrower should not only be disqualified, but also face criminal/civil penalites for defrauding the bank.
Hey Thomas,
Thanks for your input. That sounds like a brilliant idea. Sure, somebody got a loan with a “no doc,” but these subsidies shouldn’t be “no doc” handouts.
Great idea. Make even those that bought with a NO DOC show proof of their income when they got the loan. That little requirement would start to weed out the FEW that did NOT overexaggerate their income.
Thomas, when are we going to get you blogging?
Frank
Great work on this Frank. Keep it up.
As bad as this is…this can not be the last stage. This does nothing to resolve the rise in foreclosures which was to be the focus of this bailout. We are going to see more disturbing ideas in the near future is my guess.
Tom, can you provide any examples of teaser rates on Subprime loans? I don’t recall any that would be in effect this long.
Frank, thanks. I’m considering getting a blog of my own up and running, but I need to find the time. Also, a lot of these loans that are the target of this plan ARE no/low doc loans. Scary.
tchaka owen, teaser rates coupled with low or no doc loan underwriting for sub-prime mortgages are exactly how we got to in the mess we are in today. The majority of the paper that is defaulting today was underwritten from early 2005 to fall of 2006. Unlike conforming A-paper mortgages, sub-prime debt instruments were “payment stretching” products (1/2/3 year ARMs) designed to bet on asset value appreciation in the long run to offset both negative amortization due to low payment options AND 100% financing. As such, these loans had fixed rates indexed to treasuries with similar maturities at thin margins. When these mortgages repriced at a higher margin over the 5/10-year treasury, payments went ape shit. If there was no teaser rate or margin increasae, we wouldn’t be in this mess, as rates today are in line or lower with rates when these mortgages were first made.
does anyone have thoughts on what borrowing rates will be after this shakes out? would risk premiums adjust after banks’ burn wounds are fully accounted for?
the FedGov staying out of this suits my bias. if the banks want to realize trillions in losses by foreclosing on the 1.7 million people or the MBS/CDO holders want to realize complete losses by liquidating and suing the banks for renegotiating the mortgages, then that’s their call. and i would think more than a couple banks would fail as a result but w/ mortgage servicing portability, FDIC insurance, and other banks licking their chops to increase market share their absence will hardly be noticed… i’m focused on WM, C, and CFC.
of course those SWFs throw a wrinkle into all this by investing billions, from their foreign currency reserves, into the lenders delaying their insolvency.
no matter what happens, we’ll be hearing about this one for a long time.
Tom (you can just call me Tchaka), it seems that we are defining ‘teaser’ differently. I agree with your assessment that you’ve described and how we got where we are (admittedly, I already knew that), but I don’t consider a 2/28 or 3/27 to be teasers. Those are ARMs and fall rightfully within the definition of an ARM.
An example of a teaser is say……a HELOC that’s Prime + 0.25% whereby the borrower is given Prime minus 1.00% for 6-months.
Semantics? Maybe.
I think you’re misunderstanding who this “freeze” applies to. Calculated Risk has had some great analysis on the rate freeze:
http://calculatedrisk.blogspot.com/2007/12/ten-things-to-know-about-freeze.html
The targets are people in 2/28 and 3/27 subprime arms resetting in 2008+. Fico less than 660 and LTV greater than 97%. Their above market “teaser” rates of around 7-8% are going to be fixed for 5 years instead of resetting to 10%+ in 2008 and 2009. This is meant to help banks not homeowners by instead of having all 1.2 million of these people foreclose in a single year (which would trash the MBS market) spread them out over 5 years. The banks likely expect to foreclose on all these people anyway, they just don’t want it to happen all at once. So they are going to fix the rate at what the homeowners can afford, string them along for five years collecting above market rate interest and foreclose on them when they can’t afford the future reset.
The mortgage servicers don’t have the man power to examine every loan for qualification so the “big deal” of this “freeze” is a set of guidelines to mass adjust what loans they can still make a little more money off of.
Hey Andrew,
Who pays for it?
The 7-8% rates were sold off already to investors expecting in their calculations to get over 10% due to the risk associated with the loans.
So somebody has to pay those people. Either the gov writes a check or the banks eat it.
I understand if you are saying that this is better for banks vs “everyone” foreclosing, but if that was the case, the BANKs would have done this a long time ago. Forgiving a higher interest rate is MUCH more expensive then having millions of foreclosures.
Again these rates aren’t “above market rate.” Market rate for those loans is over 10% due to the risk. Banks aren’t going to be profiting if the loans are frozen at 7-8%, so somebody has to pay up.
As for most of subprime going into foreclosure, I believe the number is 10% of subprime that are in foreclosure. Maybe that number is expected to increase, but it isn’t MOST subprime.
I agree with an earlier comment that if somebody wants to be “frozen” they better show that their loan wasn’t fraudulent.
Thanks for the link.
Frank
By “market rate” I meant what it costs for banks to borrow money from the gov or other large banks (< 5% I'd guess). I don’t really understand it that well myself but from some of the analysis that I’ve read it seems the contracts attached to some of these mortgage backed securities specify a floor interest rate that the loans cannot drop below but give the mortgage servicer flexibility to modify the interest rate up or down as long as it doesn’t drop below the contractual floor (one example I saw was 7.5%). That’s why this “freeze” doesn’t require any special act of congress and doesn’t open up the mortgage servicers to investor lawsuits . You have to remember that the securities are not guaranteed investment vehicles like bonds. They are complicated multi-tiered securities where there is a hierarchy to who gets paid out first. If the fund performs well (lots of extra interest collected I guess) the lower riskier tiers get paid well. The reason investors are freaked is because even the highest “safe” tiers aren’t getting paid because of the high default rates. This is where the money for the freeze is coming from. Investors who put put money into these SIVs which are underperforming. Because of the scale involved here we’re not talking individuals but institutional investors. Pensions, local gov’t funds, hedge funds, etc. To top it off these investments were also highly leveraged making magnifying the changes in performance. I think the thing to keep in mind with any public pronouncement about fixing housing is that the government and banks don’t care about the individual homeowner. The individual homeowner is just some statistic in their aggregate probability models. They are acting to help the major banks and wallstreet. Talk has been going around about major multinational banks potentially having to go into bankruptcy if everything thats been going on came to light. Homeowners being helped is a just a side effect of trying to keep a trillion dollar market afloat.
This is a great real estate blog. I hope that you will keep it going. Hey, did you hear that Donald Trump is going to have all celebrities on his show next season. WOW!
God Bless!
Elmo
Real Estate Professional