We recently got this quote from a Forbes article:
As outlined by FHA Commissioner Brian Montgomery this morning, the White House proposal encourages lenders to reduce the principal on loans, in exchange for FHA insurance for the renegotiated loan. Sound familiar? It should to those following Washington’s fight over how best to help troubled homeowners.
Rep. Barney Frank, D-Mass., the chairman of the House Financial Services Committee has the same provision in his bill, as does Sen. Chris Dodd, D-Conn., who proposed the Senate version.
The key provision in the various foreclosure prevention plan is that in cases where homeowners are upside down and likely to foreclose, banks could allow them to write off some of the debt and refinance the homeowner into a new, lower balance loan. The proposal in congress has the new loan at 85% of the current value of the home.
So if a homeowner owed $125,000 on their house and the value of the house had decreased to $100,000, banks would have to forgive $40,000 in debt in order to refinance the homeowner into a government back FHA loan. What would a bank want do such a thing? Because if the homeowner forecloses the bank would lose a lot more than $40,000. By getting the $85,000 government-backed loan in place the risk of foreclosure would be borne mostly by the FHA. It would be the lesser of two evils for the bank, good for the consumer (even though mortgage insurance premiums would be in place), and good for the US economy in general.
We’ll see how it all plays out over the next few months…