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by CareyBot

By BILL ABOUMRAD

Editor’s note: Inman News has asked our readers to share their insights about the foreclosure problem that went viral following the subprime mortgage-market meltdown. We are offering a free pass to the Real Estate Connect conference for all published articles, and $200 to the winner of an essay competition. Click here to find out more about Inman’s "Fixing the Foreclosure Crisis" coverage.

The housing crisis in the San Francisco East Bay Area and in many regions of the country has reached dire proportions, with seemingly no end in sight. But it doesn’t have to be this way. There is a five-step solution to fixing the foreclosure crisis caused by poor lending practices of recent years.

The majority of loan defaults associated with residential mortgages can be avoided, but only if the banks holding and servicing the loans are willing to change the way they do business and begin working with their customers.

The current reluctance by banks to work out and modify existing loans with earnest homeowners who want to stay in their houses is unacceptable. For a host of reasons and mostly monetary, banks aren’t talking to their consumers about restructuring their loans unless the homeowner is technically in default. This is just wrong!

The problem with the vast majority of loans going into default is that consumers cannot afford the new monthly rates that are resetting at higher rates. For example, a borrower emerging from a period of fixed and very low "teaser" rates may experience a sudden 2.5 percent to 3 percent increase in the borrowing rate.

Take a "current" $500,000, 30-year loan at 5 percent interest and the monthly payment would be $2,685. At the reset and new rates of approximately 8 percent interest, that same 30-year note would cost consumers $3,670 per month. Who can afford a $1,000 increase in one month?

The first step is for banks to consolidate the separate functions of loan modifications, short sales and foreclosures and begin to work together on their loan portfolios.

By establishing a "Loss Mitigation Department," hard-nosed "short sale" managers could be more accommodating on the front end of a workout and reduce the number of foreclosures that the real estate-owned (bank-owned property, or REO) department later inherits. And by the time a home is foreclosed on, its value is greatly reduced from its status as a short sale.

The second step is for banks to allow borrowers to keep original "teaser" rates a little longer, and then gradually and incrementally raise rates (perhaps 1 percent per year). Due to financial market conditions, borrowers who took out loans from 2003-05 have experienced first-year increases of 2.5 percent or more after the teaser-rate period expired. Banks should view the lower, 1 percent increase as a preservation mechanism to lock in the original "asset" they acquired, namely, a performing loan versus a nonperforming loan. …CONTINUED