Escaping the Mortgage and Real Estate Quagmire

Escaping the Mortgage and Real Estate Quagmire Posted on November 20th, 2007 by The Mortgage Guy http://express-home-mortgage.com/blog

One can hear the cries loud and clear. Homeowners looking for relief from upwardly adjusting mortgages and the politician's cries that they must be helped. While I agree the home owners should be helped, I do so for different reasons. My main reason is to save the mortgage and real estate industries and probably the American economy as well.

Even if there were the political and financial will to assist these home owners by freezing or lowering their payments, chances are it cannot be done. Imposing a modification of debt notes on note holders, in such a way that it depreciates their value, is a dangerous endeavor. Such an initiative can destroy our debt markets and perhaps the securities market in general. If payment freezes or reductions were imposed, the value of the mortgage security would be negatively impacted. As it stands now, a dollar of an adjustable rate mortgage security yields "x" in interest. Furthermore, the adjustable feature is a hedge against interest rate movements, the yield is determined by the spread, which remains constant.

Lowering the payment lowers the yield thus lowering the value of the mortgage security. Freezing the payment removes the hedge aspect of the mortgage security and that too can depreciate the value of the mortgage note.

Forcing note holders into either or both of these scenarios is unfair and destroys the integrity of the mortgage security. In my opinion, the only way to accomplish either freezing or lowering payments is to do so in such a way whereby the mortgage security/note maintains it current and future values. That is to say in exchange for freezing or lowering the payment schedule, the note holder must receive something of parity.

Equity Sharing

That something of parity can be sharing in future appreciation of the borrower's home. The potential for a return on capital in the form of sharing home appreciation could offset the affects of lowering or freezing payments. It could work something like this. At the time the mortgage note modifications are agreed upon, the property is appraised to establish a base line value. At some point in the future, either when the loan is refinanced or the property is sold, the note holder would receive a portion of the home's appreciation.

As long as the home doesn't appreciate in value, it cannot be refinanced. It can only be sold either at a loss or break even. In this case, the note holder wouldn't receive any compensation for modifying the note. Except the benefit of keeping the note current and the receipt of current yield. Additionally, the expenses of foreclosure and a short sale are also avoided.

Because there is little on the table for the note holder if the property doesn't appreciate, some incentive needs to be added here. That something can be some type of agreement on the borrowers part to agree to a streamlined and discounted foreclosure process should a worse case scenario evolve.

Thousands of dollars in expenses are incurred during the foreclosure process. This diminishes the net benefit to the note holder. By agreeing to a streamlined process, thousands in fees and expenses can be avoided.

Problem Solved

The home owner wins because they get to continue to afford to stay in their home. The note holder gets something of parity for modifying the note. The debt securities market maintains it's integrity because the note holders aren't left holding the bag. Confidence returns to the mortgage securitization process and the industry is saved thereby saving the real estate industry and the American economy.

Politicians get to make themselves look good, oop I mean help, by making the proper legislative adjustments to facilitate the modifications. They can even throw a finite and defensible amount of money at the problem if needed.

I'm not a securities analyst. I cannot provide the details of what would be necessary to satisfy the parity needs of the note holder. None the less, this is a scenario that has the potential of working. It's far better than any plan that I have heard floated so far. That's because to date, there are no plans to fix our very broken system.

The Mortgage Guy has over 30 years of financial services experience. In addition to being a former Cerified Financial Planner, he currently owns a modest mortgage origination company in Connecticut.

His blog can be found at http://express-home-mortgage.com/blog.