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Where's the Reset Button?

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Posted On: 05/06/2009

Q: A large percentage of homeowners who can't pay their mortgages have adjustable-rate mortgages. If these loans reset to the current market rate instead of a higher rate, many of these people might be able to make their payments. I understand that investors would lose some of their anticipated income but they would at least get most of their investment back.

If Congress legislated retroactively that all reset fees could not be more than one-half percent, many foreclosures could be avoided and it wouldn't matter that the banks and mortgage companies didn't want to reset mortgages, they would be forced to. Why is this concept not even discussed?

A: Let's say that the government followed your plan. We would then have a situation where investors who own mortgage contracts would lose some of their income and thus the value of their asset - those mortgages they bought - would be reduced. The question then becomes who should suffer the loss?

The Fifth Amendment says that the government cannot take private property for public use "without just compensation." This means if legislation such as you propose were to be enacted then within minutes attorneys representing investors would be in court saying that yes the government can "take" some of the value of mortgage contracts by changing loan terms, but only if investors are paid for their losses.

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One of the reasons the U.S. is able to attract foreign investment is that we honor the terms of our financial agreements. If a retroactive change for mortgage loan terms was enacted, there would then be a lot less investor interest - both here and abroad - in mortgages and other U.S. debt securities. The result would likely be far-higher interest rates and far-less capital for loans.

It will be very difficult to directly change loan terms by legislation. One alternative is to buy out toxic loans, but this approach also has big problems. For instance, what price should be paid for distressed mortgages and related securities - face value or less? If less, how much?

A second problem is this: Imagine that you have a nice fixed-rate loan and you've been making all payments, but your neighbor has a toxic mortgage such as an option-ARM. The government subsidizes his loan and lowers his interest rate - but the government does not help with your loan or lower your rate. Now we have a political problem of huge proportions.

If we keep arguing about the matter long enough then the marketplace will determine the answer for us through increased foreclosures, lower home prices and deflated security values - results that won't be good for anyone.

Q: My loan has a check mark by the assumable provision. I asked my lender to provide details as to what they could offer with an assumption, but they haven't responded. Aren't they defaulting on the contract provisions that clearly state my loan has an assumable provision?

A: It's unlikely that your loan is "freely" assumable, meaning that any buyer can take over the loan. The FHA has not insured freely assumable mortgages since December 15, 1989, the VA stopped on March 1, 1988, and most private-sector lenders also stopped originating freely assumable loans around the same time.

What's more likely is that you have a loan which allows a "qualified" borrower to assume your loan - that is, a borrower qualified in the eyes of the lender. What is acceptable to the lender? Maybe today a perfect credit score and 94 percent down.

In other words, a "qualified" assumption is an illusion. It suggests that a loan can be assumed - but only if the deal works for the lender. If the lender isn't interested then expect the qualification standards to be impossibly strict.

The lender can simply say they'll only be able to decide the matter when they look at the finances of your buyer. If you don't have a buyer and financial paperwork then they have little reason to react.

For specifics, have an attorney look at your loan agreement.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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