November 26th, 2008 by Michael Oliver

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FHA (That means Congress essentially) has devised a brand new way to keep people in their homes, want to know what it is? Principal reductions, yes listen to this: Under the new program called “Hope for Homeowners” legislated in July lenders were given a way to write down borrowers’ principals to 90% of the current value (Which would give homeowners an incentive to make the new payments and stay in the home.) and then under these guidelines the borrower could in addition have the loan worked out so that the payments were no more then 38% of their income. Sounds like a great plan for homeowners’ right? The catch is that the LENDER has to submit the application to the government once the FHA approves the write-down they take responsibility for the loan if it defaults…(READ we the taxpayers) However the original lender has to be willing to write down the amount owed, before shipping it to the Federal Government! What this means if a lender even wanted to do this then let’s say a home was purchased in Tucson in 2005 for $300,000 well today it is worth roughly $200,000 PLUS the FHA says the borrower (homeowner) can get an additional 10% less then market value to give them an incentive to stay in the home. I think this part of it is between the lender and the homeowner to see what they can negotiate if the lender can talk the homeowner into taking less then the 90% of value then better for them. However if the homeowner negotiates the full 90% of market value then the original $300k gets a new principal balance of $180k. WEE! I bet that was popular with lenders right? Um no pretty much that was a no-go with the lending community as of October 1st only about 150 applications were even sent to the FHA! Why on Earth did Congress think this would work? What lender would say “Yes we’ll write off (in my example) $120,000 just to get it off the books.”??? At worst case they have to foreclose and then sell the home and (assuming they received market value/ that of course is a very loose assumption) they (the lender) then get at least that portion of the loan netting them an extra 10% back on the bad loan vs. an automatic loss of less then 10% of the market value of the home.

This is all kind of odd to say the least. OK so skip ahead recently FHA gave new guidelines to try to get lenders more willing to send the bad loans there way with these workouts. Now FHA says instead of writing them down up to 90% new guidelines only allow up to 96.5% of fair market value. This bridges the gap for some lenders thinking.

“Well if were going to lose money on this loan then at least we only lose a guaranteed 3.5% of the current market value vs. having to take it to foreclosure sale where best case is to get 100% of value and that’s far and few between.”

Of course there (the lender) still out any additional owed so again if someone bought in 2005 with a $300k loan amount and now the home is only worth $200k they eat the$ 100k plus 3.5% of $200k (which works out to be an additional $7,000 totaling a $107,000 LOSS)

Now here’s the really crazy part of the very few of these new “Hope For Homeowners” modified loans that have been done and backed by FHA (Federal Government) the RE-DEFAULT RATE IS 50% meaning after all the work has been done the homeowners re-default one half the time and end up losing the house anyway. ON TOP OF THAT the Federal Government then has to take a further loss because of the costs of foreclosing on the home, plus any additional losses if the real estate market has further declined! This in my mind is very easy to see the Lenders most likely have only allowed the borrowers that they were getting a great deal from to let it go to FHA. Meaning the lender was at risk of losing more money through a very fast declining market and decided to cut bait and let the FHA handle this extremely high risk borrower in a fast declining local market! If you as a homeowner didn’t fit this model then the bank figured they would save money by just foreclosing and re-selling the home. Thus saving the amount in excess of market value FHA wanted them to give up!

Again this is NOT THE ANSWER to fixing housing or even keeping people in homes. Furthermore this is just a way to get tax payers to subsidize more stuff they should not have to pay for! The only way for the real estate market to correct is to let it run its course. As I have said in previous posts do a stimulus package to encourage buying of foreclosed homes and help builders to get building again, this isn’t exactly “letting it correct itself” but it is assisting to get people buying again and in essence doesn’t cost as much because it is (from a homebuilder stimulus) putting people back to work (which gets them paying taxes again) and helps the overall economy. The economy in Tucson is very dependant upon construction, due to the serious downturn of the real estate market for the past 3 years a lot of jobs have been lost. Now since Tucson is a fast growing metropolis a lot of those workers went into other fields however the overall economy has felt the pain of essentially having no real new housing industry to work within. We still have “new homes” being built just at a trickle pace vs. the historical numbers of the past 10-20 years.