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When You May Wish For A Lower Credit Score

Contributed by mm | December 28, 2007 5:54 AM PST

The quick fall of the housing market and the widespread impact to the American homeowners have already prompted a long list of prompt political actions. All of them came with good purpose, but not all are rational. The often-touted rate freeze and loan-modification program, announced by the White House on December 6th, is a good example of how ridiculous some programs are designed.

Here is a quick run-down of the test that subprime borrowers need to pass to qualify for a "fast-track" interest rate freeze:

1) FICO Test: If your FICO score was under 660 when you applied for the loan, and hasn’t improved for more than 10%, you pass the test. Having too good a credit score -- say, above 660 -- and sorry, you are out of the game (for being creditworthy and therefore you don't deserve to be rescued).

2) Mortgage Status Test: The mortgage needs to be "Current": which means the homeowner is not more than 60 days behind on payment right now, and hasn't been more than 90 days late during the last 12 months. (Read: if you are already up to your neck, you don't deserve the rescue.)

3) LTV Test: Homeowner needs to have no more than 3% equity in the house. (Read: if you happened to be a rational homeowner by putting a good down-payment, you probably can bail yourself out without external help.)

4) Principal Residence Test: The property used as collateral should be the borrower's principal residence. (Finally we have something fair.)

5) Monthly Payment Test: The mortgage's monthly payment must be scheduled to increase by more than 10 percent after the scheduled reset. (Read: you are expected to tighten your belt if your mortgage payment will only increase marginally.)

One can reasonably conclude that what the program intends to help are those who were really not suitable for being homeowners, and is it our government's wish to keep them in their home even they are behind on creditworthiness and have no equity?

Now I don't even bother to point out the moral hazard involved in the bail-out (many other bloggers wrote about it better than me), and maybe I should feel good that it is a voluntary program supported by lenders and no taxpayer money will be used, but should our ownership society be built this way?

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This Post Has Received 2 Comments. Share Your Opinions Too.

jack Commented on December 28, 2007

I don't get the negativity about the plan. It makes perfect sense to me. The only thing that does not make sense is that it took so long to nail down.

Targeting the middle credit crowd makes sense:
1) If you target the low end people that are already delinquent you accomplish nothing. They are already behind or in jeopardy of missing payments, freezing their rates will not help them. These people need to sell their house and downgrade to a smaller one or go see their loan officer and make special arrangements. To be sure they need help, but including them in a rate freeze plan is not the sort of help they need.
2) The people with good credit or lots of equity can already refinance and lock in new rates. No need to create a plan for them. This white house proposal does not discriminate against people with good credit, on the contrary it says that these people already have better options and they should use them.

I also reject the moral hazard arguments:
1) As far as I can tell there is no bailout on the table. People will not magically be given more equity in their house, nor will financially stupid people be forgiven their debt. Instead their loan terms will be changed such that they make lower payments for a longer period of time. The banks lose because they don't get the principal back as quickly as they expected. The borrowers lose because now they pay even more in interest and are slaves to a mortgage for more than 30 years. No one is getting off easily. What is being done is that homeowners and banks don't want a lot of defaults and this plan creates a fast track to restructure the debt to keep the defaults from happening.
2) I reject the argument that the government is breaking the sanctity of contracts. Before the mortgages are resold as bonds they are put into a trust with a charter that allows the trust to negotiate new terms with the borrower if a default on the loan in imminent. ( sorry I can't find the link to support this right now ). The white house plan targets only those people who are in immediate danger of defaulting on their loans and proposes a way to restructure. This is in keeping with all the paperwork put in place when the Trusts are set up. If the borrowers don't like the plan then they can negotiate a new one or force a default. And the investors who bought shares in the mortgages can't complain because they really bought shares in a Trust whose charter gives it the right to restructure the loans. So no contracts are being violated.

The only way I see any moral hazard coming out of this is if the loans are refinanced with the Uncle Sam signing on to bail out the new loan in case of default. That would create a moral hazard. But until that is put on the table all the moral hazard talk is just speculation.

synchro Commented on December 29, 2007

mm, the whole rate freeze plan is supposed to help lenders and the investors who own the securtized loans -- it is far better and cheaper to have debt slaves keep paying a manageable interest rate, than to have the house foreclosed and sold at a huge loss (thereby marking to market all the unsold inventory too). It is a scheme to buy time, so that when the Fed eventually panics and start to inflate the problem way, they may be able to get the principal back. This has nothing to do with helping homeowners. In fact, if I have the means, I would have purchased ads in all the major newspaper, ENCOURAGING AND URGING people to default and walk away from the mortgages that they have NO HOPE EVER to pay back.

What we need is a good old fashioned depression that bankrupt away and write off all the stupid, unproductive, delusional investments and schemes.

It would be a cleansing and fitting end to 30 years of debt delusion.

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