Okay, as long as we’re talking politics this week, let’s just dive in head first. I’d like to discuss the latest federal “relief” plan that made news this week. Here’s an AP story from Monday: Obama Offers Mortgage Relief on Western Trip
LAS VEGAS — President Barack Obama offered mortgage relief on Monday to hundreds of thousands of Americans, his latest attempt to ease the economic and political fallout of a housing crisis that has bedeviled him as he seeks a second term.
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His jobs bill struggling in Congress, Obama tried a new catchphrase — “We can’t wait” — to highlight his administrative initiatives and to shift blame to congressional Republicans for lack of action to boost employment and stimulate an economic recovery.
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While Obama has proposed prodding the economy with payroll tax cuts and increased spending on public works and aid to states, he has yet to offer a wholesale overhaul of the nation’s housing programs. Economists point to the burst housing bubble as the main culprit behind the 2008 financial crisis.
Wait, what? No, the main culprit behind the crisis was all the insane financing, derivatives, bogus ratings, leveraging, and all of the other nonsense that went on during the housing bubble run-up. The bust and financial crisis were just the inevitable consequences of the near-universal death of responsibility at both the personal and the corporate level.
Moving on…
Under Obama’s proposal, homeowners who are still current on their mortgages would be able to refinance no matter how much their home value has dropped below what they still owe.
Because there are so many people whose homes are worth half what they owe who just want to refinance to a lower interest rate. Or something.
“Now, over the past two years, we’ve already taken some steps to help folks refinance their mortgages,” Obama said, listing a series of measures. “But we can do more.”
At the same time, Obama acknowledged that his latest proposal will not do all that’s not needed to get the housing market back on its feet. “Given the magnitude of the housing bubble, and the huge inventory of unsold homes in places like Nevada, it will take time to solve these challenges,” he said.
Please, don’t “do more.” Hasn’t the government already done enough? Killing financial oversight, over-promoting “ownership,” over-expanding Fannie & Freddie, bailing out irresponsible banks…
Presidential spokesman Jay Carney criticized Republican presidential candidate Mitt Romney for proposing last week while in Las Vegas that the government not interfere with foreclosures. “Don’t try to stop the foreclosure process,” Romney told the Las Vegas Review-Journal. “Let it run its course and hit the bottom.”
“That is not a solution,” Carney told reporters on Air Force One. He said Romney would tell homeowners, “‘You’re on your own, tough luck.'”
I’m certainly no Romney fan (he’s probably my least favorite potential 2012 challenger), but he’s right on this one, and Mr. Carney has got it backward. Foreclosures are not the problem. The problem is over-inflated values that got completely detached from all sound economic fundamentals. Foreclosures are the solution, not some sort of government-forced refinance plan that helps people to continue throwing good money after bad for decades to come.
It seems I was a little unclear on why exactly I think this is a bad plan. The main reason I’m not a fan of this “help people refinance their underwater mortgage” program is what I said just above: It only “helps people to continue throwing good money after bad for decades to come.”
Let me try to explain via an example. Let’s say you bought a 3-bed, 1.75-bath Seattle-area home in 2007 for $419,000. You put down 20% and got a 6.6% rate on a 30-year fixed-rate mortgage. That puts your total monthly PITI payments at about $2,600.
Today your house is worth about $280,000. You still owe about $314,000, so despite putting 20% down, you’re 10% underwater (more if you count the costs of selling). If you refinance into a new 30-year mortgage at today’s rate of 4.2%, you can drop your payments from $2,600 to about $1,900.
Pretty good, right? $700 a month savings!
But what if instead you were able to do a short sale (or default, if the bank won’t play ball), rent for a few years, then buy a home at today’s lower prices?
Going rent for a home like yours in your neighborhood is around $1,400 a month—$500 a month cheaper than what you’d be paying if you refinanced your underwater mortgage. Five years of renting at that price (even allowing for some increases in rent) will cost about $25,000 less than five years of paying the $1,900 a month refinanced mortgage, and $67,000 less than paying your original mortgage.
If you take the $67,000 you save by renting for five years and put it into a $280,000 home comparable to what you used to own, your monthly payment (if rates go back up to 6%) will be just $1,600—$300 less than if you take the government’s deal and refinance today. The numbers work out even worse for you to take the deal if you originally put no money down or have a home that is even further underwater.
Here it is in table form:
| Scenario | Payment Today | Payment 0-5 yrs | Payment 6+ yrs |
|---|---|---|---|
| do nothing | $2,600 | $2,600 | $2,600 |
| HARP refinance | $2,600 | $1,900 | $1,900 |
| rent, then buy | $2,600 | $1,400 | $1,600 |
That’s what I’m talking about when I say that continuing to pay an underwater mortgage is “throwing good money after bad.” It’s short-sighted and in my opinion a larger drain on the economy than encouraging people to get face the consequences of their poor purchase decisions, get out of these houses and move on with their lives.