The Bush Administration’s plan for lenders and loan servicers to freeze monthly mortgage payments for selected homeowners who aren’t able to afford the reset interest rates on their adjustable-rate mortgages is more about politics than governance and is likely to hurt more homeowners than it helps. Indeed, the plan seems to have been designed to benefit a relatively small group of people at the expense of both their neighbors and the broader economy that the plan is supposed to protect.
The main benefits will accrue to those folks whose mortgage interest rates will be frozen at artificially lower levels. Some of these people were victimized by predatory lending practices and deserve some sort of assistance. But most of these folks knowingly took out high-risk mortgages because they wanted to buy a home they otherwise couldn’t afford, they counted on price appreciation to create a windfall and guarantee their ability to refinance later or they wanted to convert the equity in their home into ready cash for consumer expenditures.
These behaviors paid off handsomely for some in the form of rapid home price appreciation and cheaper living in the initial years of the mortgage when the introductory interest rate applied. But now that that party is over, the government has told these folks they won’t have to face the adverse consequences of their behavior. Instead, they can keep their house and their introductory interest rate for as long as another five years. That’s clearly a win-win situation.
But someone has to pay for this largesse, even if the frozen interest rates aren’t the rock-bottom rates extended to prime borrowers.
The obvious payers are the investors in mortgage-backed securities who won’t receive the higher returns they’d expected on their investments. That’s not to suggest that anyone should shed tears over these losses because high returns always come at high risk, and the investors should have been aware of these risks just as the borrowers whose loans were packaged into the investments should have been.
Others also will pay, although perhaps in less-obvious ways. The interest-rate freeze indirectly punishes homeowners who opted for fixed-rate mortgages or less risky types of adjustable-rate mortgage and renters who chose not to purchase a home because they knew they couldn’t afford to do so. Those who acted conservatively and responsibly are now forced to subsidize their neighbors’ risky behavior.
The argument for this subsidy is that the frozen interest rates will prevent a huge wave of foreclosures that otherwise would devalue the properties of those who took out sensible mortgages that they could afford. But that argument is fallacious because the borrowers who can qualify for the frozen interest rates by definition have little or no equity and credit scores south of 660. Consequently, they are still at risk of foreclosure for other reasons and the foreclosures that are forestalled today may still happen five years hence when the frozen interest rates expire. Either way, neighborhoods aren’t shielded from the negative effects of foreclosures.
Homeowners who took out a subprime adjustable-rate mortgage, but don’t qualify for the interest-rate freeze won’t benefit either. These folks aren’t eligible because their mortgage was originated too soon or too late, the interest rate has already reset or will reset too soon or too late, the equity in their home exceeds 97 percent of the home’s value or they now have a credit score that’s higher than 660. In effect, these people are punished for their ill-timed or less-risky behavior. Some of them will lose their homes to foreclosure while the others will also subsidize their more fortunate neighbors.
Prospective home buyers will bear the cost of the interest-rate freeze as well. Some of them will be unable to buy a home because the artificially frozen ARM interest rates will prevent foreclosures that otherwise would have put more homes on the market at lower prices. Others won’t be able to obtain financing because the artificially frozen interest rates on existing mortgages will scare away investment capital and result in higher interest rates on new mortgages.
Whether the frozen interest rates will protect the U.S. economy is also questionable. Since the plan is voluntary on the part of the lenders and loan servicers and the qualifications are so narrow, it’s possible that only a small number will benefit. In fact, the voluntary nature of the plan may make the entire argument irrelevant, and that’s where politics comes into play. The big announcement creates the impression that the Bush Administration has taken action, when in fact, the outcome may be unaffected.
Marcie Geffner is a real estate reporter in Los Angeles.
Copyright 2007 Marcie Geffner. All rights reserved. No part of this article may be used or reproduced in any manner whatsoever without written permission of the author.
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