The Obama administration is considering a proposal to help distressed homeowners by subsidizing lenders who cut the interest rate on mortgages, according to sources familiar with the discussions.
The sources cautioned that the administration is still weighing several options for addressing the country's growing foreclosure problem. The Treasury Department has set aside $50 billion for a homeowner relief program, which officials said would likely be announced within the next week. The sources spoke on condition of anonymity because the plans are not final.
The initiative would include both carrots and sticks for lenders, said lawmakers briefed by the administration. For example, it would likely endorse legislation to allow bankruptcy judges to change the terms of mortgage loans, a measure opposed by the industry. But the program would also also include legal protections for lenders that modify loans but fear being sued by investors. Government subsidies could be among the inducements for lenders, the lawmakers said.
Under one proposal now being actively discussed, the government would share the cost to lenders of reducing interest rates for cash-strapped borrowers, said the sources. For example, consider a homeowner with a $200,000 mortgage and a 9 percent interest rate who now pays about $1,700 a month, including taxes and insurance. Lowering the interest rate to 5 percent, would reduce the payments to about $1,160. The government and industry would each chip in to cover the roughly $540 difference.
It is unclear how the program would be administered, but mortgage financing companies Fannie Mae and Freddie Mac would likely be involved, according to one source with knowledge of the plan. Homeowners could be required to apply for the program and submit to an affordability test as well as receive an appraisal of their home, the source said.
"It has the advantage of being fairly simple. You don't need a large federal bureaucracy to do it," said Howard Glaser, a housing industry consultant and former housing official during the Clinton administration. "It is far cheaper to reduce mortgage payments than it is it to acquire a distressed property or even guarantee the loss on that property."
Under this plan, Glaser said, the government would also be able to reach homeowners before they fell into delinquency -- a problem with many existing loan modification plans.
But deciding who would qualify for such a program could be difficult, said Edward R. Morrison, a professor at Columbia Law School. And in some cases, lowering a borrowers interest rate is not enough to make the home affordable, he said. "This is an important issue. Not all foreclosures can be stopped," said Morrison. "Not every homeowner can afford a mortgage, so we have to carefully target these plans."
Alan White, an assistant professor at Valparaiso University School of Law, said lenders should be lowering interest rates to affordable levels without government aid. In most cases, putting homeowners in a new loan with lower payments is still a better deal for lenders and investors than foreclosure, he said.
"Why should we subsidize them to do what it is in their economic interests?," White asked.
Consumer advocates and the banking industry are anxiously awaiting the Obama administration's plan for addressing the housing crisis. Government officials have already said it would establish industry standards for modifying the loans of troubled borrowers. The Office of Thrift Supervision, which regulates savings and loans, has urged its lenders to stop foreclosures until the plan was unveiled.
Republicans, meantime, have tried but failed to add a measure to the economic stimulus package that would have driven down mortgage rates to as low as 4 percent. The Treasury Department was considering a similar proposal last year and lawmakers said it is still under consideration.
"We would still like to an opportunity for lower rates to be available for all homeowners who are eligible for refinancing," said Mary Trupo, a spokeswoman for the National Association of Realtors.
So far, government and industry loan modification efforts have struggled to make an impact on the foreclosure problem. Many borrowers fall back into delinquency even after receiving help, including lowering interest rates.
In a research note released yesterday, Fitch Ratings estimates that after a year, between 60 percent and 70 percent of homeowners whose loans have been modified will have missed two or more payments. Reducing the principal balance borrowers owe could help improve the performance of the loan, Fitch said.
"Although principal reductions have not yet been used to an extent which allows a clear determination on their success, Fitch believes that both features may be needed in order for a modification to be sustainable and therefore, reduce re-default rates," the statement said.
The debate comes as home values continue to plummet. The national median existing home price fell 12.4 percent to $180,100 during the fourth quarter, compared with the same period a year ago, according to a National Association of Realtors data released yesterday. In the Washington area, median sales prices fell 26 percent to $295,100 in the fourth quarter compared to the fourth quarter a year ago, the data showed. Nationally, foreclosures make up an increasing portion of sales, 38 percent in the third quarter and 45 percent in the fourth, according to the group. Falling prices have made is a driving factor in the country's foreclosure rate.
Staff writer Lori Montgomery contributed to this report.