The U.S. credit crisis is a serious problem, and the federal government’s plan, as announced Aug. 31 by President Bush, is merely a cosmetic solution.
The proposed plan can be broken down into a few parts: First, the plan offers homeowners who refinance out of adjustable rate mortgages (ARMs) temporary tax relief to help ease the financial pain; second, the plan calls for the Federal Housing Authority (FHA) to aid in the refinancing of some of these problem loans; and finally, the plan will introduce some educational programs aimed at helping people avoid foreclosure.
The following are reasons why the portion involving FHA will fail to aid most of those actually in need:
FHA requires that people have at least 3 percent equity in their home, but many of the people who truly need help are in the areas where home values have dropped significantly. As a result, some of those people are upside down in their houses, which means they owe more than the house is worth. Thus, they have nowhere near the required 3 percent.
With the way housing prices have been dropping across the nation, plus the fact that 100 percent financing was a common practice, there are a lot of people with no equity at all. Many homeowners who have equity in their properties owned their homes during the housing boom, assumed home values would continue to rise and proceeded to use the equity in their homes to buy things such as cars, vacations and plasma TVs.
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Many who got in on the housing boom early made a lot of money; not all of those people deserve to be bailed out, because a good portion of their problems were caused more by irresponsible spending and borrowing rather than a “bad” loan product.
Secondly, as part of the FHA guidelines, people are required to have debt-to-income (DTI) ratios of 29 percent or less for their mortgage expense and 41 percent or less for total debt load. Many who received subprime loans had total DTI ratios of 45 percent or higher. In fact, many borrowers obtained subprime loans specifically because they needed flexible DTI ratios in order to qualify.
In addition, when these people originally qualified for their loans, rates were generally lower. When additional credit card debt—incurred as they began to fall behind on their mortgage payments—is taken into account, it seems that for many, the chances of meeting the DTI ratios are slim. Those who do qualify are the ones least in need of help. If they fit within the ratios outlined and still cannot make their mortgage payment, they likely have a money management problem. In such cases, refinancing will probably just delay the inevitable.
The last problem with FHA loans as the solution to the foreclosure crisis is that these loans have strict maximum limits. The maximum loan amount varies based on the home prices in each county; the overall program cap is $362,700, though in most places it is much lower, and the lowest county cap across the U.S. is $200,160. In many parts of California, for example, this cap means that almost no one will qualify for assistance.
Bush is trying to get Congress to approve measures that would increase this limit, but even the proposed limit of $417,000 will still fail to help many people in high-priced areas. Because people are in jumbo loan territory at that amount, they are ones who need extra help. With lenders lowering their risk tolerance, jumbo loans are difficult and expensive to obtain, so these individuals stand little chance of refinancing on their own. Furthermore, those in high-priced areas who don’t qualify for this program will still have to pay for the assistance being given to people in the lower-priced areas via taxes.
The best part of Bush’s plan is the educational classes that will be offered. A lot of people could be helped if they took the time to go to these classes and learn what steps they can take to avoid foreclosure, such as negotiating with the bank. These classes have the potential to help a good portion of the people involved in this debacle.
All in all, Bush’s proposed plan has many holes in it. It is doubtful that most people in trouble will be able to utilize this program. Further, the plan appears biased toward those who live in lower-priced areas.
The real concern, given that the FHA provisions of Bush’s plan appear to be merely cosmetic, is the dangerous precedent a “bailout” of homeowners would set in the U.S. If people are bailed out of their risky endeavors, they will likely continue to take undue risks because they won’t perceive the actual consequences. At the same time, responsible people who did not take extra risks will be forced to pay for the mistakes of those who did. This has the potential to create a system that rewards those who make poor financial decisions, because they are able to experience the benefits in good times and the government will cover their mistakes in bad times.
One thing is certain: Our government cannot “bail out” our economy forever. Eventually many people will be forced to learn a painful lesson. The longer this goes unchecked, the more painful the lesson will become.
