Sounds good doesn’t it? The government (in an election year) is going to come to our rescue by convincing the banks and investors who hold the adjustable mortgages to freeze the interest rate on these loans so that the borrowers are not hit with a huge payment increase that forces them into foreclosure. The question is, will it help or is it just election year politicking?
After reading almost everything I can get my hands on on this in the last couple of days (thank you to everyone who keeps sending articles to me, I get a little something out of all of them), I have to say it is a lot of politicking that will be a little helpful. The reason is: The freeze will not be available to everybody. You will not qualify if:

• You are already late on payment or in foreclosure
• You have re-financed your home since you purchased it.

That is the simple version and there are other reasons you might not qualify, but those two wipe out about 90% of the people I know who could benefit from the program. That doesn’t mean the program doesn’t have merits. Anything that helps slow foreclosures is a very welcome approach, but I think the problem is much larger than this program will help.

How big is the problem ultimately going to be? Good question. First of all, we have to realize that the blame for the problem runs through everybody involved in the process. There was enough fraud committed (sometimes by people who didn’t understand that what they were doing was illegal) by everyone. That includes buyers who lied about their income, mortgage brokers who advised them to do so, real estate agents who sold the homes these people had to lie to afford, and banks who loaned the money. Interestingly enough, the people with the least responsibility are going to be the ones asked to shoulder the losses and I believe that is the weakness of this solution. A friend of mine sent me an article from Sunday’s San Francisco Examiner that outlines this situation.

The article points out that the people who are really going to get hurt by this rate freeze are the investors who bought the loans. Here is a quick primer to explain how the investors are involved, skip it if you already know this:

When you take out a loan with your mortgage broker, it is issued by a bank or
other lending institution. This bank takes all the loans it issues and
packages them into one large group of loans and sells that package to
investors. The investors buy the loans at a discount and make money by
taking your payments. They understand that some of the loans will go bad,
but they buy the whole package at enough of a discount that the bad loans are
covered.

Now, these investors purchased these adjustable loans knowing that the payments they would receive would go up significantly when the loans adjusted or the loan would be paid off as the home owner re-financed. Either way, it is good for the investor who purchased the loan package as a legitimate investment. Now, the plan is for these investors to waive their right to receiving these higher payments in exchange for the homes not going into foreclosure. Sounds like a good compromise - although probably not if you are one of those investors.

Fortunately for them (and unfortunately for US Banks and the real estate market), the investors have another option. All of these loan packages have clauses that state the investor may return the loans to the banks and be paid the full face value of the loans if it is ever determined that there was fraud involved in the issuing of the loans.

Oops.

Remember when we talked about the borrower lying about his or her income and the mortgage broker knowing about it? Well, the banks knew about it too (they aren’t that dumb or they wouldn’t have all the money). So, you basically have fraud on all levels, giving the investors the right to ask for their money back. So they’re left with the quandry, “do I accept a much lower return on the investment I was told was safe, or do I return it and get all my money back?” I know what 99.9% of the people I know would do. Problem is, there isn’t any money to give them. Values have fallen so you can’t sell the house to get the money and the individual banks and lenders have been going out of business like crazy. So, where does this leave us? With the government trying to lean on foreign investors (many if not most of these loans were purchased by foreign governments and investors) to accept a lower interest rate in exchange for a stable US economy.

I sure hope it works, but not sure I want to count on it.