Foreclosure-rescue legislation benefits both borrowers, lenders

by Julie Hirschfeld Davis - Jul. 13, 2008 12:00 AM
Associated Press

The foreclosure-rescue legislation moving through Congress would let financially strapped homeowners who would normally be considered too debt-ridden to qualify for safe, government-insured mortgages refinance their home loans through the Federal Housing Administration to get more affordable loans with lower monthly payments.

It would help those who have seen their mortgage rates balloon just as their home values are plummeting, allowing them to keep their homes if they show they can make the payments on a new loan.

It also carries substantial benefits for banks and other mortgage holders, which could avoid often-costly foreclosures. After taking some loss on their existing loans to homeowners, the lenders would be assured of a government payoff if their new replacement loans turn sour. The bank would have an incentive to put mortgages into the program in cases in which the losses they face are smaller than what it would cost to foreclose.

How the program would work

In the first example below, the homeowner could afford a new mortgage and the bank would have a clear incentive to allow an FHA-backed refinance. In the second, the borrower is so financially strapped that the mortgage holder would have little interest in agreeing to a refinance; the bank could do better by foreclosing. The examples do not include insurance premiums and property taxes that may be added to the monthly mortgage payment.

Example 1

Home bought in 2005 for $200,000 - now worth $150,000. Loan is $200,000.

FHA PLAN

Borrower: Shows he can afford a loan for 90 percent of the home's value: $135,000.

Lender: Agrees to lower the principal of the loan by 15 percent of the reassessed value: $127,500 (a 36 percent loss).

Borrower: Monthly payment of $1,470 at 8 percent balloon rate falls to $875 at 6.75 percent fixed rate.

FORECLOSURE

Borrower: Loses home.

Lender: Seizes home and pays foreclosure expenses, leaving $110,000 (a 45 percent loss).

Example 2

Home bought in 2006 for $150,000 - now worth $120,000. Loan is $150,000.

FHA PLAN

Borrower: Shows he can afford a loan for 75 percent of the home's value - $90,000.

Lender: Agrees to lower the principal of the loan by 30 percent of the reassessed value: $84,000 (a 44 percent loss).

Borrower: Monthly payment of $1,200 at 8.9 percent adjusted reset rate would fall to $600 at 7 percent fixed rate.

FORECLOSURE

Borrower: Loses home.

Lender: Seizes home and pays foreclosure expenses, leaving $87,600 (a 41 percent loss).

Source: House Financial Services Committee, Bankrate.com.