Mr. Mortgage's Recipe for Fixing the Housing Mess

Mr. Mortgage, who maintains the Mortgage Lender Implode-O-Meter website (worth bookmarking cuz it's chock-full of good information, daily updates, and useful links about the real estate/mortgage biz), wrote an awesome article about the real roots of housing crisis. His recipe for helping homeowners out of their current troubles makes a lot of sense:

It is time for the very same financial institutions that created all of this to do what’s right and re-underwrite every loan originated between 2003 - 2007 using prudent underwriting guidelines. Then, they must reduce the principal balance to what the borrower really earns using a 28% housing and 36% total debt-to-income ratio at a market rate 30-year fixed loan. When home owners are levered to 28/36 DTI they are able to save money and live a decent lifestyle. If they go upside down in their property who cares - they are still able to save money and live the lifestyle their income level allows. At 28/36, their home once again becomes a place to live.

If reducing the principal balance to 28/36 on a market rate 30-year fixed loan winds up being $100k lower than the present value of the home, the bank should receive the differential through an equity warrant to 90% of the value of the property. This way the home owner is not upside down in the home, they can freely sell or refi, they are not getting anything more than they deserve and the bank is still protected. But the home owner gets all of the upside. Anything less and the program will fail. If the borrowers can’t prove income through bank statements at the very least, then they need to leave the house and rent. They should have been renters all along.

For the small percentage of folks who can afford the payments with DTI’s under 28/36 but are underwater solely due to house price depreciation, principal balance reductions to 90% of the present value of the property is likely in order WITH a full-recourse provision to thwart fraud.

For the minority with equity who may owe $200k on a $400k home or have no mortgage at all, you get a multi-year tax break and a lollipop. By de-leveraging and stabilizing the consumer, you will stabilize house prices much faster, which will benefit you. Left unchecked and the consumer de-leveraging and housing price depreciation will continue for years, which brings you down too. You may end up underwater in your home unless the right solution is brought forth.

These things will not prevent housing prices from coming down over the next few years to reach a level of affordability consistent with present mortgage rates and lending guidelines. But at least it would be the best way to begin to undo the irresponsibility of the past five years and get back to basics where house prices and affordability are based primarily on traditional factors such as rents, incomes, interest rates, macroeconomic conditions and sentiment.

This would of course be a tough pill for the banks and investors to swallow, but Mr. Mortgage makes a good case that it's really all their fault.