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Posted by adam.dada on July 21st, 2008
Chicago, IL
By A.B. Dada
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On numerous housing bubble forums and blogs, I’ve noticed some people are recommending a tactic that may help stave off foreclosures while attempting to bring the market back to more realistic prices: the idea that the bank should re-appraise the property, and modify the loan downwards to the new market value. This would be the equivalent of a short-sale from the current owner to the current owner, with the bank eating the loss.
There are many reasons why this is a terrible idea, but parts of it do have merit. First of all, it would be difficult to keep EVERY homeowner who is underwater from asking for a reappraisal and a lowering of their principal owed. Banks would be overwhelmed, and finding the current true market value of a home is impossible except in a sale situation. Appraisers were, en masse, one of the cause of the bubble by their poor appraising and bad use of discretion in looking at housing value, not just prices.
One option that might work is the idea of a short sale auction with a preapproval amount for the current underwater homeowner. I’d say it would be important to limit these short sale auctions to homeowners who are already 90 days late on their mortgage, but have the income necessary to pay some sort of mortgage. Why 90 days late? It would keep homeowners who can afford their mortgage payment, but don’t want to, from taking advantage of a rewriting of the terms of the loan. 90 days late gives a homeowner a terrible hit on their FICO score, so those with clean reports will likely not run into default just to try to get a lower monthly payment.
The first step would be to verify what the homeowner really can afford, taking into account a fixed rate mortgage, outstanding debt elsewhere, and their income levels. Once a realistic figure, no more than 3X their annual income, is decided upon, the bank can then offer the homeowner a price that they can keep their home for. Let’s say that a homeowner who is underwater with a terrible loan package makes $50,000 per year, but their mortgage was based on a $250,000 home (5x income). The bank, after looking over every aspect of their debt and income, sets the new recalculation value at $150,000 maximum.
Then the home goes to auction. The current homeowner is allowed to bid up to $150,000 on their own home, preapproved for a mortgage rewriting. If anyone else bids over $150,000, the homeowner loses their home, and the bank makes a short sale. If no one else does, the homeowner keeps their home, gets a new mortgage, and the bank takes a loss.
I don’t like this option, but it is a possibility because it is no different than any other short sale or auction, it just allows the chance that the current homedebtor can stay in their house, saving the bank significant money in rehabilitation or tax liens or other costs.
