11.09.2011 0

Is the American dream being perverted?

By Rick Manning — The American dream of homeownership has changed dramatically over the years.  People who grew up in the Depression era would often celebrate the day they owned their home free of debt by having mortgage burning parties.

Later generations became more accustomed to the long-term indebtedness, but always had the expectation that their home value would go up, allowing them the freedom to move whenever they wanted due to the increased equity in their homes.

Now, those assumptions are being challenged with a new report showing that 28.6 percent of American “homeowners” actually owe more money than their home is worth.

These “underwater” homeowners actual situation hasn’t changed.  If they have a fixed term mortgage, they agreed to pay a certain amount of money each month for a period of time until the loan amount was satisfied.

If they have an adjustable rate mortgage, their payment will fluctuate over the term of the loan until the loan is satisfied.

The actual value of the home is only relevant in this situation if the person wants to sell the home or change the loan terms — i.e. refinance.

Real estate, like any other asset class, is subject to valuation ups and downs.  Unfortunately, the failure of homebuyers to understand that the home they bought in 2007, often with little to no down payment, might be worth significantly less money in 2011 is at the heart of calls by some prominent Democrats both in Congress and in California state government for these homeowners to be relieved from their paper losses on their real estate investments.

What is the rationale for politicians wanting taxpayers to pay to lower the mortgage amounts owed by their neighbors who owe more than their homes are worth?

Fear that these homeowners will decide that it is no longer worth it to them to continue paying their mortgage, when they can rent a similar house down the street for less money.

Please note again that the value of a person’s home on any given day has zero impact on the amount they pay to their mortgage company.  The home value did have an effect on how much the bank was willing or legally able to lend them to purchase the home, but lowering the principal of the loan can only have one intended effect — encourage these same people to refinance their homes and lower their mortgages a few dollars.

One of the primary assumptions a lender makes is that the person they lend the money will pay them back.  The reason people with bad credit pay higher interest rates is because they have a history of being an unreliable lending partner, and a risk premium is built into their loan.

Any rational lender would run, not walk, but run away from any homeowner seeking to refinance after getting their mortgage principal reduced.  If this same homeowner was willing to walk away from their previous deal, it is highly likely that the same person would be a much more risky bet than the average Joe who just pays his mortgage on time regardless of the appraised value of his home.

The other possible objective is to allow that homeowner who is underwater to move more easily.

Nothing prevents a homeowner who is underwater on his/her home from selling their home and purchasing another if they choose.  They just have to make the lender whole on the amount of money they borrowed.  If they owe $100,000 on the home, but it only sells for $90,000, then they need to pay the difference to the lender and they can be out from under their obligation.  An uncomfortable situation, but that is the deal that was made.

Yet, for some reason, politicians cannot resist wanting to use other people’s money to help people in “need.”  The irony is that their help often encourages the exact behavior that they claim to want people to avoid.

The bottom line in the “crisis” of 28.6 percent of American homeowners owing more than their homes are worth is that the value of their home has no impact on their ability to pay the agreed upon mortgage payment.  In fact, as the property tax component, which is based upon the appraised value of the home, is reduced, the payments become lower than they originally agreed upon.

The real crisis is that some people choose to walk away from these loans because they no longer want to make the payments not based upon economic hardship but based upon a business decision that they can pay less in a rental elsewhere and a willingness to bear the hit to their credit rating.  Throwing taxpayer dollars at these individuals to lower their loan liabilities forces those who pay their bills to reward the bad behavior of their neighbors who have decided that the no longer want to.

America is a forgiving nation.   America has always rejected the notion of debtor’s prisons, and our bankruptcy laws reflect that spirit of giving someone multiple chances to get it right. However, it is perverse for politicians to try to use the money of those who pay their bills to fund the mortgages of those who they fear might not.

That is a path that can only end badly.

Rick Manning is the Director of Communications for Americans for Limited Government.

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