Making Irresponsibility Affordable

Making Irresponsibility Affordable

Published: Mar 6, 2009 at 10:18 am

by Gina Breckenridge

Sometimes I still find myself amazed by my own naïveté. I had read a lot of speculation about what would be included in Obama’s foreclosure “crisis” plan, now termed the “Making Home Affordable” plan, but I held some small amount of belief that much of it simply was speculation. I also mistakenly thought that the 31% rule was going to be applied to net income. That’s higher than my preference of 25%, but still workable in some circumstances.

Since it is once again “imperative that we continue to move with speed,” I’m going to outline some of the problems with “Making Home Affordable.” I know that many people are having trouble keeping up with and absorbing all the news with everything happening so quickly, and I’m beginning to believe that the members of the Obama administration are not only acting with speed, but also taking speed, and that’s what’s preventing them from being able to engage in rational thought.

The disturbing but least egregious part of the proposal is the intent to modify mortgage payments by either reducing interest rates, extending the term of the loan, reducing principal, or a combination of these, to no more than 31% of the borrower’s gross income.

I won’t bore you with all the figures, but I actually sat down and calculated that. I was very generous in my calculations, assuming a household income of $65,000 per year, which is considerably higher than the national average. Also, state tax rates can vary from 0% (seven states) to as much as 10.3% (guess where that is), and some states use marginal rates, as the federal government does. It wasn’t possible to come up with a meaningful median, so I used the PA tax rate of 3.07%.

I factored in federal, state, Social Security and Medicare taxes, and allowed only a small bit of additional payment for escrow, such as taxes and insurance. I did not take into account any city or county taxes, or unemployment insurance. The final figure was a staggering 40% of net income, which would be making Dave Ramsey roll over in his grave if he weren’t, fortunately, still with us to tell people to stop being stupid with money.

Although some families might be able to swing a mortgage payment that’s 40% of their take-home pay, that’s highly unlikely with many of these mortgages. A very large percentage of troubled mortgages are subprime and were given to borrowers with substandard credit scores and little to no down payment. In other words, they already had a history of not saving for a home, and not paying their bills on time. Of the borrowers who have had loan remodifications in the past year, when all this started, well more than half are already back in default.

The most egregious part of the program is the proposal to allow bankruptcy judges to modify mortgage contracts. If you read no other part of this article, please read this part and understand the implications.

This administration is proposing to allow judges to arbitrarily alter legally-binding contracts made between businesses and consumers. If the business doesn’t willingly alter the terms, a judge can tell them they must. Let that sink in for a minute.

Beyond that, Fannie Mae and Freddie Mac are already covered in other parts of the proposal. This part would almost exclusively cover subprime mortgages, most of which are held in mortgage-backed securities owned by private investors, hedge funds, insurance companies, etc. This means the debt is not held by one entity, but has been chipped apart and sold to millions of investors. If a mortgage servicer modifies a loan based on a judge’s order, two things happen. The mortgage servicer is a ripe candidate for a lawsuit filed by shareholders, and the federal government has violated the Fifth Amendment by taking that which is private property without just compensation.

I won’t go into the details of many of the troubled mortgages being 80/20 loans, other than to say what that means is the borrowers took out an 80% loan, then borrowed the down payment for the other 20% because they didn’t have it or didn’t want to put it up. The administration hasn’t yet come up with a plan for dealing with the secondary loans, but I’m sure something creative and bold is in the works.

Please don’t get me wrong. I hate seeing responsible home buyers lose their homes. I have empathy for those who are in foreclosure due to job losses, medical expenses, or anything else that wasn’t foreseen. What I have no sympathy at all for is people who were irresponsible in home purchases and are intent on dragging the rest of us down with them.

Speaking of personal responsibility, part of the Obama plan is to extend these benefits only to “responsible” home buyers. I can’t wait to see how they end up defining the word “responsible.”