Thursday, December 10, 2009

American Dream 2: Default, Then Rent

I was reading this article in the Wall Street Journal this morning:

Not surprisingly, people will default on loans where they owe a lot more on their house than it's worth. A couple of thoughts come to mind: If you could afford a $500,000 loan when you purchased a house, assuming that you still have the same income, you should still be able to meet the payments If it drops in value to $250,000 this has no bearing on the affordability of the payments. But why would you do that when you could default and then rent or buy the house across the street, which now only costs $250,000 and is just as nice as the one you are in?

A few of the people in the piece were offered slightly better mortgage terms from their lender, but nothing close to as good as just walking away from their home. So the banks end up having to sell a house for $250,000 that they're owed $500,000 on.

Here is a proposal which would help everyone: The bank decreases the principal on the above home to $225,000. The owners now have every motive to stay and the bank is more-or-less in the same situation as if there was a default. Here is the added twist: The terms of the agreement are that if the house is ever sold, the bank gets the first $25,000 of profit plus 50% of any additional gain. The 25k is to recapture the 10% equity granted to the homeowners (the house was valued at 250k, but principle was reset to 225k). The remaining 50/50 split incents the owners to stay put for the long-term and yet allows the bank to recapture some of its losses if the house ever regains value.

It seems win-win to me: The owners save the trouble and expense of moving and a hit to their credit and still get the lower monthly bills they could get by defaulting and then renting. Banks initially loose about as much as they are loosing anyway, but they have a long-term chance of getting a bunch of it back instead of no chance of getting it back.

Crikey! I should patent this!

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