Politicians float a number of plans to solve the problem of too many homeowners being underwater, when the balances on their mortgages exceed the values of their homes. Being underwater with little hope of rising prices gives homeowners an incentive to default on their mortgages. That depresses home prices further. But simply writing down mortgages to the market value of homes creates a moral hazard and inequity. Why act responsibly when lenders will write down the loan after you make a bad purchase? Why should those who aren’t underwater but still saw declines in their home values not get some kind of a break?
In the past I’ve highlighted solutions from others that involve safeguards, hurdles, and equity kickers for lenders so that homeowners are encouraged to stay in their homes and pay their mortgages but the moral hazards are reduced. Here’s a summary of three keys to a successful mortgage restructuring program.
If borrowers have a stake in the deal, that might keep some from trying to score a reduction. Under what’s commonly called a “shared equity” plan, underwater borrowers have their principals reduced to their property’s current value. In exchange, if the price of the property rises in the future, the lender would have a claim on a portion of the increase.
Using an example from economist Bill Wheaton at M.I.T., here’s how the plan could work: Say a borrower bought his house for $100,000 a few years ago. But then the price of the home has fallen by 40% to $60,000. Rather than risk foreclosure, the lender could lower his mortgage’s principal to the home’s current value. In turn, the lender would have a 50% claim if the home’s value rises in the future – capped at $40,000. So years from now when the owner sells the home for – say, $90, 000, the lender would collect $15,000 of the sales proceeds.