Sen. Jeff Merkley Has a Great Idea for Underwater Homeowners

Oregon Senator Jeff Merkley has drafted a modest proposal for creating a modern version of the Home Owner's Loan Corporation (HOLC) to bail out underwater homeowners. The HOLC was created as part of the New Deal and was designed to preserve homeownership. Its purpose was to take short term mortgages (which were the norm back then) and convert them to longer-term mortgages like the ones we normally see today. 

Sen. Merkley's proposal is different -- we don't have short-term mortgages to contend with -- but serves a similar purpose. Under the Senator's plan, an entity known as the Rebuilding America Homeownership Trust (RAH) would purchase underwater mortgages and offer non-delinquent homeowners three options for refinancing their loans. 

Families that are current on their loans would be able to go to any lender and refinance their mortgages into one of the three RAH-approved mortgages. The lender would then sell the loan to RAH, which would service the loan until it was paid off or sold.

The first option would be a 15-year fixed rate mortgage at 4% interest. This option would allow borrowers to regain equity faster, but would have larger payments than a traditional 30-year fixed rate mortgage. 

The second option would put borrowers into a 30-year fixed rate mortgage at 5% interest. This option would have much lower payments than the first, and would allow borrowers to remain in their homes, but with slower equity recovery. 

The third option involves two loans: a mortgage at 95% of the home's current market value and a "soft second" mortgage that holds the remaining balance of the loan. The "soft second" would not accrue interest or have payments due for five years. The effect is that the monthly payments would be quite low, and only increase marginally after the first five years when the second mortgage goes into repayment.

The Senator's materials mention that since no principal is forgiven, the "moral hazard" argument about principal reductions is made moot. Also, since borrowers need to be current on their payments to avail themselves of the program, Sen. Merkley deftly avoids the "people will default on purpose" crowd. 

So how will this program pay for itself?

The RAH Trust would sell bonds to private investors. These bonds would function like Treasury bonds. They would be sold at low interest rates (2.3%). The money gained would then be lent out at a higher interest rate (4-5%). The spread between these rates would provide padding to cover any mortgage defaults. Additionally, the money paid in by performing loans would help offset the cost of the program and fund more loans. The presentation materials go into considerable depth and demonstrate how the program would actually make a profit. 

This proposal is workable. It might not provide principal reductions, but it does help homeowners restore equity in their homes and it makes payments more affordable for those who need relief. It also has a chance of making it through even the most gridlocked Congress. 

Unfortunately, this proposal will never see the floor of the House or the Senate unless people demand it. Borrowers who are interested should contact their Representative and Senator. Sen. Merkley's goal is to get pilot programs running in several states without the need for Congressional action. However, for the program to truly be as large as it needs to be, there will have to be some action taken in D.C. sooner or later.

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