Cost of More Foreclosures to the Economy Is Too High
Government should lead the way on right-sizing underwater mortgages
February 6, 2012
American families have too much mortgage debt weighing them down—for many it is unsustainable, particularly those with underwater mortgages, where the debt is greater than their home's value. Resolving underwater mortgages is essential to keep families in their homes, restore housing markets, and encourage economic recovery.
There are many ways to act:
- Federal and state governments have been helping low- and moderate-income families with home repair and debt reduction for over 30 years—we could allocate (admittedly scarce) resources to more direct assistance.
- Private lenders have begun helping many homeowners by modifying mortgages, some encouraged by federal incentives, some because they recognize it is in their best interest. We could increase incentives (as proposed by the president) and push more lenders to reduce principal at little cost to government.
- Homeowners and lenders can share the cost, making both better off. Shared appreciation mortgages replace the original too-big mortgage with a smaller, sustainable first mortgage plus a second loan that allows the lender and the homeowner to share the costs and benefits of restructuring. Shared appreciation costs government nothing, and one servicer has been using it to great result for years. We could encourage much wider use via regulations, the market power of Fannie Mae and Freddie Mac, or targeted financial incentives.
If we do not act, the consequences will be severe. More foreclosures will weaken neighborhoods and disrupt struggling families. Some households will remain trapped, missing out on better jobs elsewhere, waiting for inflation and monthly payments to slowly grind away the debt. Underwater loans keep people from selling their homes, even if they would be better off moving elsewhere for a job, to be closer to family, or to make room for kids. With few homes bought and sold, it will remain harder for everyone to know what the right price of a home is, and therefore harder to restore the confidence that homes purchased today will retain their value. Until we restore that confidence, we cannot hope for a full economic recovery.
There are many homeowners who took out reasonable mortgages for homes at the going price, made their payments, but got trapped in underwater loans by the bursting housing bubble. Right-sizing mortgages can help those responsible households get above water more quickly. It can provide better returns to lenders by preventing costly defaults and foreclosures. It will also help housing markets recover. Government should lead the way, but it need not foot the entire bill.