Some Mortgage Legislation I Like (and Some I Don't)

In the clutter of all the nonsensical and counter productive mortgage legislation, there appears to be some beacon of hope that a few things will come out of Congress that are sensible and productive, not counter productive. Suze Orman picks up the story on a few pieces of legislation that I believe will have a positive impact on mortgages and the weakening economy. The first piece of legislation has to do with the concept of short selling, something that happens to avoid foreclosure. Here is a bit from Suze...

The most significant change under the new law is tax relief for people who sell their home for less than the remaining balance on their mortgage. Under the old law, even if the lender agreed to "forgive" the difference between the home sale price and the mortgage balance, the IRS wasn't so lenient. Tax regulations required lenders to report the amount that was forgiven as gross income received by the seller, in effect handing sellers a tax bill on income they never actually received.

For example, if you sold your home for $200,000 but your remaining mortgage balance was $225,000, you would've faced a tax bill on the $25,000 difference that your lender forgave.

The concept of short sales is relatively unknown but will become relatively popular given the nature of the market we are in. Here is how it works. Let's say you owe 250k on your mortgage but cannot sell your property for any more than 225k, and you are falling behind and have no hope of catching up. The bank may allow you to sell that property for 225k and forgive the extra 25k because it still works out better than the bank foreclosing themselves and then selling that property. Selling a property for less than what you owe is the concept of short sales.

What this law does is eliminate the tax on the difference. Frankly, this tax is punitive and ridiculous. The reason I like this law is that it takes the Ronald Reagan approach to domestic policy. Show me a problem and there is likely a tax I can cut or eliminate to solve it. Prior to this law, the difference between what the property was sold at and what was owed (25k in my example) was then treated as income on the next taxes. Now, if you think about it, that is patently ridiculous. Folks that are short selling are doing it because they are desperate. They can't afford their mortgage and they can't sell the property for the value of the mortgage. Do these sorts of folks sound like someone that can then afford the tax bill on an extra 25k in income they didn't actually see? Because many more properties are now in this position, where the mortgage is more than the property is worth. The tax, now eliminated, added an extra layer of punishment that the current mortgage market simply cannot afford. Right now, the most important thing is to get as many of these folks out of these properties as quickly as possible. Anything that stands in the way of that must be eliminated. Eliminating this punitive tax is exactly that sort of fix.

The second piece had to do with Mortgage Insurance. Here is how Suze explained...

There was also a small bit of good news for homeowners with private mortgage insurance (PMI): Congress voted to extend the deductibility of PMI premiums until Jan. 1, 2010.

Only homeowners with adjusted gross incomes below $100,000 are eligible for a full deduction (it phases out between $100,000 and $110,000), and only mortgages for primary residences originated after 2006 are eligible. A PMI trade association estimates this tax break will result in an average $350 annual savings for homeowners eligible for the deduction.

Mortgage insurance is a nasty and interesting fee. It is paid by borrowers on any so called conventional loans, those insured by Fannie or Freddie, that are over 80% of the value of the property (thus on a 200k property any loan above 160k will have Mortgage Insurance). The nasty part is that the insurance is paid on behalf of the bank. This mortgage insurance is paid in order to cover the bank on any loans that default. It isn't paid by the bank but rather by the borrower. It is like me paying for somebody else's car insurance. Now, the reason that mortgage insurance wasn't tax deductible is because it is technically not interest, it is insurance. There is a deduction for interest expense, but not insurance expense. Under the new law, Mortgage insurance will become tax deductible, though only for those making less than 100k (which I don't like). While this will likely have minimal effect on the mortgage crisis itself, I am always a fan of any tax reduction, which this is.

As much good news as Suze reported, she also reported some bad news. She didn't treat it as such, but Suze did give details on the rate freeze and it confirmed my suspicions that is ridiculous and non sensical.

If your mortgage has already reset, you're out of luck.

•

Only adjustable rate mortgages made between Jan. 1, 2005, and July 31, 2007, are eligible. (Option-only loans aren't eligible.)

• You're also out of luck if your lender happened to keep the loan on his books rather than sell it into a securitization pool -- only securitized loans are eligible for this plan. Is there better proof that this effort isn't so much about bailing out homeowners as bailing out investors?

• Finally, your interest rate must reset between Jan. 1, 2008, and July 31, 2010, and the new payment must be at least 10 percent higher than your current
payment. Meet all the above criteria and get your restructure rolling before the initial reset and you may be in luck. But keep reading:

• Only subprime adjustable rate mortgages are eligible. What qualifies as subprime? Well, the quick test is that you must have a FICO credit score below 660. If you have a higher score, the lender will look at your income to determine eligibility.

The first bit of nonsensical policy is the last thing Suze mentions,

If you have a higher score, the lender will look at your income to
determine eligibility.

Those that qualify will have to meet an income to debt eligibility. In fact, those that have incomes to low for their debt will be the one that will be eligible. First, this is a moral hazard. The folks that are rewarded are the ones in the worst financial shape. This is exactly opposite of how mortgages are supposed to work, reward goes to the best financial shape. Second, unless the debt and income eligibility is clearly defined, this will be a free for all. Since everyone will want to wind up in the category that freezes rates, they will all claim their income qualifies them. If this is left to the bank on the other hand, they will likely make qualifying nearly impossible.

These loans will be available only to those that are securitized. This is a peculiar and ultimately irrelevant thing to do. Nearly all sub prime loans were in fact securitized so this will likely include everyone though Suze is right when she hypothesizes that this may be more to save the securitizer than the borrower.

The rate freeze is only available to sub prime but not to prime. Again, the government has created another moral hazard. Sub prime are the loans for those with marginal credit. Because they were irresponsible, they had to take a sub prime loan. Then, they were even more irresponsible and took on loans they couldn't afford. For this, all these borrowers are being rewarded with a wholesale change of the terms of their loans. This is yet another example of a moral hazard.

Finally, Suze mentions a program called FHAsecure...

FHASecure, launched in the summer of 2007, is another government push to help the mortgage-stressed. The crux of this program is to make it easier for borrowers hit with resets to refinance.

This program is either window dressing or a recipe for disaster. FHA has strict limits on debt to income. Most of the distressed borrowers are in situations where their debt to income is out of whack. They got into so called stated loans where they likely lied about how much they made, and they likely perpetuated the problem by refinancing and using new found equity when the real estate market was hot. FHA allows no stated and their limits are quite tight. If these limits aren't adjusted almost none of these folks are going to qualify. If they are, I believe that will soon cause a crisis in sub prime because most of these folks are simply in over their heads. They owe more than they can afford. The problem is not their rate, but the amount of their loan. If they are allowed to go into FHA, I believe that in the next couple years their will be mass defaults on FHA.