Tuesday, June 2, 2009

Compromising positions

"Foreclosures: No End in Sight" presents the reality of a system that has failed to connect borrower and lender to one another. The borrower, even with a reduced monthly payment, is no more than a renter when there is no equity pot at the end of the rainbow. The incentive to protect one's investment is severely diminished when all the borrower sees is the lender reaping the ultimate benefits of the property.

So too, the lender has to feel that a unilateral reduction of the mortgage principal is an unwanted and unjustified step without adequate consideration. Why not consider an alternative in which both sides gain from the transaction?

Reduce the borrower's monthly payment to one that comports with the reality of the property value and the borrower's financial abilities. However, do not automatically reduce the principal balance of the loan. Rather, provide that with each monthly payment made, a portion of it (eg 50%) is deemed to be a principal reduction of the loan amount, until the aggregate principal reduction by these monthly payments is equal to the reduced loan amount established by the understanding of the parties.

For example, a homeowner has a 30 year loan is at $300,000 with principal and interest payments of $2000 per month, but the present value of the home is only $275,000. If it is agreed that the ultimate loan amount is agreed to be $250,000 and that the borrower can now only afford to pay $1600 per month, then the following unfolds: the mortgage payment is made at $1600 per month, of which $800 per month goes towards an agreed upon reduction of the principal. Over approximately a 5 year period, the buyer keeps gaining equity on the home until the mortgage amount is reduced to the $250,000. There is thus an incentive for the borrower, who now is making affordable payments, to keep making the same and thus increase his likelihood of having equity in the property in the relatively near future. The lender is not ' giving away' equity in the property without there being continuous payments made over a significant period of time.

This would seem to create incentives for both parties, so that there is no clear 'winner and loser'. I am not an economist but I am a realist. We have to create a situation in which all parties see the benefit of participating to make the foreclosure problem one that can become less daunting. What have we got to lose?

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