debt recovery legislation
debt recovery legislation
On July 31, President Bush signed legislation that is intended to provide relief for thousands of Americans in danger of losing their homes to foreclosure. In this article, I’ll provide a brief explanation of what led to the legislation’s enactment, the details of how it works, and who will benefit from it.
Why It Happened
In the last year, the housing market has been crippled by a severe credit crunch, caused in part by subprime loans gone bad. During the housing boom, a lot of loans were made to people who couldn’t make a normal down payment and couldn’t realistically afford their monthly mortgage payments. These subprime borrowers got loans because salespeople were paid for making loans, regardless of whether they were good loans or bad loans.
Many subprime loans were a foreclosure waiting to happen, and these forced sales are fueling a vicious cycle in the real estate market, with foreclosures dragging down prices and slumping prices encouraging people to walk away from mortgages bigger than the value of their homes.
How the Law Works
The housing rescue bill is intended to break this cycle by avoiding unnecessary foreclosures without simply throwing money at banks and borrowers. Like most laws, the goals are simple but the details are complex because the law tries to anticipate every possible contingency and abuse. The result is a 694-page bill. A six-page summary is at http://banking.senate.gov/public/_files/HousingandEconomicRecoveryActSummary.pdf.
The most important part of this law authorizes the FHA to insure distressed mortgages if the bank replaces the existing loan with a 30-year, fixed-rate mortgage equal to 90% of the home’s current value. For example, if an at-risk borrower has a $210,000 mortgage on a home that is only worth $200,000, the bank could convert this loan to a $180,000 fixed-rate mortgage.
Here are some additional details on how the law works:
1. The law only applies to owner-occupied homes purchased between January 2005 and June 2007.
2. The current mortgage payments must be at least 31% of the household’s gross monthly income.
3. The household must pay off any other debts on this home, such as a home equity loan, before receiving a new loan and must not take out a new home equity loan unless it is needed to repair the home. A new home equity loan must be approved by the FHA and the total debt on this home cannot exceed 95% of the home’s value.
4. The lender will obtain an appraisal of the home’s current value and issue a new loan equal to 90% of the home’s appraised value. The lender will waive any fees and penalties from paying off the existing mortgage and accept the new loan as a paid-in-full replacement for the existing mortgage.
5. The lender must verify the borrower’s income, wealth, and credit score in order to determine if the borrower is likely to make the new monthly mortgage payments.
6. If the borrower sells the home or refinances the mortgage, they will pay the FHA an exit fee equal to 3% of the mortgage balance and a share of the profits if home prices increase (100% if done within a year, 90% if within 2 years, and so on down to 50% if in the fifth year or later).
Who Benefits?
The bank’s incentive is that it avoids an expensive foreclosure and obtains FHA insurance that the monthly payments will be made; the bank’s cost is that it takes a loss on the distressed loan and must pay the FHA a fee equal to 3% of the home’s appraised value. The homeowner’s incentive is that he or she gets a fixed interest rate on a smaller loan; the cost is that the homeowner must pay the FHA 1.5% of the new loan balance each year and share any profit it realizes from the home with the FHA.
This is a voluntary program, so homeowners and banks must decide if a new loan makes sense. Homeowners are most likely to benefit if they are struggling with their current mortgage payment, but can afford smaller payments. Banks are most likely to benefit if they would suffer a large loss by foreclosing. It is predicted that some 300,000 to 400,000 homeowners will participate.
This bill is obviously good news for people who can use affordable government-backed loans to keep their homes. It is also good news for the real estate market. In most U.S. cities, a home is still a great investment. With prices down and a glut of homes on the market, now is also a good time to be a home buyer. If this housing bill gets credit flowing again, everyone—home buyers, home sellers, and home owners—will benefit.
About the Author:
Dr. Gary N. Smith is Fletcher Jones Professor of Economics, Pomona College, where he teaches Macroeconomics, Mathematical economics, Money and Banking, Securities Valuation, and Statistics. He holds a Ph.D. in Economics from Yale University. Gary is the co-author of Houseonomics: Why Owning a Home is Still a Great Investment (FT Press: $17.99) FTPress.com
Article Source: ArticlesBase.com – The Housing and Economic Recovery Act of 2008: Why it Was Passed, How it Works, and Who Benefits
