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How the 'Last Chance Mortgage' could ease the housing crisis.

Imagine that every homeowner living in Maine, New Hampshire, Vermont and Rhode Island were facing foreclosure. That is the situation we face today with over 2 million families now on the brink of losing their homes. And we've got a second housing crisis in full swing: a lack of affordable housing. We can solve both problems at once, and do it in a cost-efficient and humane way. I'm calling this plan the "Last Chance Mortgage" fund.

Our proposal starts by asking the question: "Why did all these families get in trouble?" Some were greedy and some were tricked by lenders offering mortgages with low interest "teaser rates" But I believe that most were families struggling to achieve a middle-class lifestyle and a decent school for their children. While we do not have good data about the people currently facing foreclosure, we have extensive data about people who have recently filed bankruptcy.

In the vast majority of cases, people who file bankruptcy do it for one of three reasons: they lose their job; they get divorced; or they have a serious illness. According to the Sept. 7 Prevention magazine, "Half of all recent family bankruptcies are due to medical bills and illness, even though over 75 percent of these families had insurance"

What we are proposing is not a bailout. There will be and should be consequences to both the lenders and the borrowers. But if we act quickly, we can limit the damage to our neighborhoods, save money and end up better off.

We propose that the federal government establish a large mortgage pool--The Last Chance Mortgage. Homeowners in danger of foreclosure, would have the option to refinance their current mortgage with this special Last Chance Mortgage. If they choose this option, their house would be appraised and a new mortgage would be written at 90 percent of the appraised value, or the outstanding balance on the current mortgage loan, whichever is less. Prepayment fees and similar penalties would be waived.

Details are important, but at a conceptual level, let us assume that Last Chance Mortgages would have a 3 percent interest rate. People who refinanced their current mortgages with a Last Chance Mortgage would still need to prove that they could meet the monthly payments including principal, interest, insurance, property taxes and a 1 percent reserve. Homeowners receiving a Last Chance Mortgage get to stay in their house, but would lose the opportunity to sell the house for a profit. They get the stability of home-ownership and monthly payments they can afford, but not the upside.

How it would work

Let me illustrate how this might work with an example based on the following assumptions:

* Our distressed homeowners have a 30 year subprime or adjustable rate loan for $250,000 at a 10 percent interest rate.

* Their house currently has an appraised value of $200,000. Property taxes and insurance average $700 per month

In this scenario, our family is currently paying approximately $2,894 per month on the mortgage, including escrows for property taxes and insurance.

If this family decides to switch to the Last Chance Mortgage, the first thing that happens is that their mortgage drops to $180,000 (90 percent of the appraised value of the house). Coupled with the reduced interest rate, their monthly payment drops to $1,609 per month, which includes the 1 percent (or $1,800 per year) reserve. Presumably with this lower payment, the family can afford to stay in their home.

The 1 percent reserve is designed to ensure that the house continues to be well maintained. Like the property tax payment, this $1,800 would go into an escrow account, which the homeowner could only pull out for defined capital repairs like fining the roof or replacing an appliance. Even though homeowners would not benefit from appreciation in the value of their homes, they would still have a strong incentive to use this reserve to make the house as comfortable and livable as possible. In addition, as the homeowners paid down their mortgages, they would be entitled to receive this principal back when they sold the house.

Under normal circumstances, would most people choose a Last Chance Mortgage? Probably not. They would want the opportunity to benefit from appreciation in the value of their house. But if the choice is this mortgage or lose your home, the Last Chance Mortgage would be attractive. It would enable a family to get through some rough times. And when they moved on, we would have a house that would be affordable for some other family that could not afford market-rate housing. In other words, we would have an inventory of permanently affordable housing, for working people.

The lenders

What about the lenders? Would they be willing to go along with this arrangement? I am confident that they would. In the example cited above, the lender would receive $180,000 in cash as payment for their mortgage. The transaction would be quick, simple and require very little work on the lenders' part.

For the lender, the alternative to the Last Chance Mortgage program would be to foreclose on the house. This process could take months, and in the meantime the family living in the house would have very little incentive to maintain it.

Then the lender would need to hire a broker or auctioneer to sell the house and might have to settle for a fire-sale price, well below the $200,000 at which the house was appraised. Between the legal fees, the brokerage fees and all the other expenses, the lender would be lucky to net $180,000, to say nothing of the time and hassle involved.

In addition, most lenders do not like to foreclose on properties and kick people out of their homes. In fact, once the program was worked out with key lenders, I suspect that they would help to market it to potential homeowners. Most lenders would be delighted to be able to say to a troubled homeowner: "Here is a way out of your problems." And for trustees of securitized mortgages, this. pro, gram would offer a solution that could be crafted so it greatly lessened their chance of being sued and extricated them from a difficult, time-consuming process.

Our better selves

How did we get in this mess? Clearly some lenders and mortgage brokers sold homeowners a product they could not afford. Some homeowners were greedy or had unrealistic expectations that house prices only went up. And some homeowners felt that with the rapidly increasing cost of housing, they needed to take a risk and buy now or they might never be able to afford a home.

But if we focus primarily on motives and punishments, we will not come up with a solution.

Instead, we need to focus on helping people stay in their homes and building an inventory of permanently affordable housing. Not every house will qualify for a Last Chance Mortgage, nor will every homeowner. It will be challenging to develop an appropriate set of rules and guidelines. But if creatively designed and intelligently administered, the Last Chance Mortgage Fund might be a powerful tool in combating massive foreclosures.

Since the government's cost of borrowing is more than 3 percent, there will be a cost for this program. There will also be a cost for administering both the initial mortgage loans and the ongoing oversight and administration. But if we use the government's current borrowing costs for 30-year bonds at 4.95 percent and assume that it will cost another 0.25 percent to administer the program, then the subsidy cost for the house in our example would be about $229 per month.

By contrast, the monthly cost under the Section 8 program for housing a family in a two-bedroom apartment in Boston is currently $1,343 per month, of which the government typically pays at least 50 percent. And this calculation does not include the cost of administering the Section 8 program.

Similarly, compared to the expense of building new, affordable housing, the houses acquired through the Last Chance Mortgage program will be a bargain. If we had done this 10 years ago, when the median price of housing was $122,000, we would now have a stock of housing that teachers and firemen could afford.

There are lots of details to be worked out. The most efficient .program would be national in scope, but it could also work at the state or even city level. The time has come to act boldly. If we can save a large number of families from foreclosure, save neighborhoods from empty, deteriorating houses and begin to address the lack of affordable housing in this country, we might turn a potential Tragedy into something positive.

John H. Vogel Jr. is permanent adjunct professor at the Tuck School of Business at Dartmouth College.
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Author:Vogel, John H., Jr.
Publication:New Hampshire Business Review
Geographic Code:1U1NH
Date:Sep 14, 2007
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