Saving Mortgages After the Bailout

A tiny part of the discussion during the recent taxpayer-screw to the credit industry was what to do with those mortgages that are still risky, but haven’t yet fallen into foreclosure. If you have judges being given the ability to change the terms of the loan contract, then what guidelines should they follow? How do you balance fairness to the struggling homeowner, to the banks, and to the rest of the home-owning public that knew enough to not enter into shady credit deals in the first place?

Some have suggested lowering interest rates, some for forgiving any current late debt, some for…well, it doesn’t matter because none of these ideas makes any sense. Most of the solutions that I’ve seen basically are all rah-rah for the home-owner, but exact a heavy price on the lender. As skeevy as some/many of these lenders are, the fact is that they found their suckers, and those suckers did sign legal [ill-advised] contracts. Making lenders write off all of this debt is no way to plug the holes in the dikes. In fact, you’re just inviting another flood of unscrupulous lending.

My thought is that first we need to separate the loan industry from the banking industry. Yes, Keating and his ilk (with congressional help) managed to bilk Americans just as effectively as is being done in the current crisis, but at least it was localized to the S&L industry. Now, you can do it all in a bank: savings, checking, loans, investing, etc… if one pillar falls, the entire structure is in danger. It’s easier to regulate and manage discreet industries, and creating a separate loan industry should be a priority.

Next, adjustable-rate mortgages never struck me as a good idea. Even if it costs a little more, knowing from month-to-month and year-to-year what your payments are going to be enables the borrower to reliably budget and avoids surprises (plus, assuming a growing economy, your payments in “real” dollars go down over time). So: for home mortgages only allow fixed rates. Also, borrowing against equity is never really in the lender’s or borrower’s best interest. While there are some extraordinary circumstances where it can be justified, for the most part they should also be discontinued.

I would also like to see the lenders have a greater interest in their borrowers being successful. Currently, the majority of mortgage payments at the beginning are mostly interest, not much principle. So, once most of the interest has been paid, the lender really has little stake in the borrower completing the loan. It’s actually better if the borrower defaults so that a new loan can be made (it’s known in Vegas as gambling with the house’s money). I propose that even at the beginning of a mortgage that the interest amount stays at an equal proportion through the length of the loan. Now the lender has a vested interest in your ability to pay off the loan. This allows allows the borrower to build up equity in the property much more quickly.

Here’s the thing: the lending industry knows that you’re never going to follow the logic of how they figure out the interest. Let’s say you want a $100,000 loan. A 30-year fixed rate mortgage at 7% will mean that you will pay not only the $100,000 of the loan, but also about $139,508.90 in interest over the 30-year life of the loan. So…that “7%” loan actually costs you an average of 58.25% of each payment in interest (it’s actually worse, as the industry top-loads the first 20 years to be mostly interest). Now do you want to buy a house? Industry practices need to change so that borrowers know exactly what they are paying.

As for immediate practical matters: I think that troubled mortgages need to be handled on a case-by-case basis. Those who seem able and willing to continue to make payments on their homes should be offered a mortgage term that can be realistically managed. Let’s say that a couple can’t afford their current 30-year mortgage. If they can afford the payments for, say a 40-year fixed mortgage, then simply extend the payment period. This is the one and only period when such a long mortgage is to be offered, and should be the only time when interest is paid at the top end.

I think, too, there should be a window where people who were tricked into these sorts of loans get a free pass out of the deal. They should be able to, for a short period of time, abandon the loan without foreclosure proceedings and without the action appearing on their credit records. By allowing those already in a world of hurt to bow out honorably, bankruptcies can be avoided and people will have a chance of rebuilding their likely damaged credit in short order. I’d also make this retroactive to those who did abandon their properties in the past 18-months, provided they can show cause. What to do with the abandoned properties? Sell ’em for whatever the market will bear to those who didn’t abandon properties (no fire-sale trading up strategies here), and who can actually make the payments per smart credit practices.

See…the balance is to make sure you don’t scuttle either the banks or the people. Neither should those at fault (the lenders and borrowers) be given oodles of cash, credits, or other bailouts. The runaway train of credit needs to be managed in such a way that no one derails and the boiler not only doesn’t blow, but doesn’t lose steam. It’s not easy, but this is the sort of plan that I think most people and businesses could accept. A balanced deal should make everyone a little bit happy and a little bit had. I think we can do with without too much craziness (i.e. the less Congress does, the better).