There has been a lot of discussion lately about the effectiveness of President Obama’s Economic Stimulus plan. Depending on whom you listen to and what day it is, the total cost fluctuates. Let’s just say that it is north of $800 billion US. With that being said, I am not convinced that what he and Capitol Hill are talking about is really going to address the root of the problem.

Lawmakers in Washington are making the argument that we need to spend this money on further providing liquidity to the financial institutions in the United States. In some cases that may make sense under the auspices of ensuring a stable financial market, but in others I am not sure how much it is really going to help. The typical quip you here is that “Banks need to start lending again”. Well, they are lending; they are in fact desperate to lend, since most investment banking deals have dried up, the large financial institutions are on the lookout for sustainable, long-term revenue in the form of interest payments from credity worthy borrowers.  The issue is they are looking for it from reputable and qualified borrowers.

Case in point; John Doe borrower purchased a home in 2005 with an interest only, adjustable rate mortgage. That first mortgage was at an 80% LTV (loan to value ratio) on a home he purchased for $275,000. John Doe then had his mortgage broker secure second mortgage (home equity line of credit) for the additional 17% of the home’s value. This leaves John Doe having to bring $8250 US, plus some additional funds for closing costs, to the closing table

The issue is that John Doe got this loan through a program that used to exist called a No Doc Loan. Another words, it was a loan based on stated income. Yep, you just told the mortgage broker what your income was, and they took your word for it. Your loan package sailed through underwriting and within 30 to 45 days, John moved into his dream home. Granted, John Doe had a pretty good credit score at the time; above 700, so he easily qualified for the loan because he made $150,000 a year as an IT Manager. So you are thinking; what’s the problem?

John Doe did not make $150,000 a year; he only made $99,000 a year. So, given a first mortgage of $220,000 at 5.75% and a second mortgage of $46,750 at a variable rate of prime plus 2% (around 8.75% at the time), his monthly payment for principal and interest would be approximately $1055 $341 $1396 Interest Only or approximately $1600 on a 30 year amortized basis. This does not take into account his escrow amounts for taxes and insurance, which would add about $225 a month to either payment. When you add in those figures and take into account his real salary of $99,000 a year, one can see that a payment of over $1800 a month for John is somewhat of a stretch, but he can manage it since he will either sell the house in a couple of years or refinance it in a couple of years into a fixed rate mortgage.

If you fast forward to now, John Doe is in trouble. The interest rate on his interest only loan has now is variable, he has a mountain of credit card debt, and his kids are going to college. The long and the short of it is; John Doe could not really afford the house when he bought it and he certainly cannot afford it now, no matter what sort of economic stimulus package the government passes. Even if he could talk his bank into re-amortizing his loan and dropping the interest rate to 0%, he most likely could still not afford the principal payments on the house, given his current economic situation and the fact that he cannot pull out equity from his house to pay off the other debt that he has amassed over the last three years.

This may sound like a far fetched scenario, but it is what is playing out across America at an alarming rate in many, many cases. Just look at the statistics that are released every month with regard to the foreclosure rates in the US. Furthermore, this same sort of scenario is starting to affect holders of jumbo mortgages, who have lost their jobs, and are straddled with a large mortgage payment.

There is not short term fix for this scenario and the entire real estate collapse that we have experienced in the US over the last year. It took several years to occur and it will take several years to balance out. It is a simple issue of supply and demand. There are too many houses on the market which puts downward pressure on home values across the board. Plus given the tighter lending standards, individuals cannot turn to their home equity to de-leverage themselves from the debt they have amassed.

Banks are lending, they are just not lending like they used to. Since cheap credit has dried up, they are relying on the old tried and true model of collecting deposits from their customers and then using those deposits to lend to credit worthy customers. There is no secondary market for mortgage paper currently except for Fannie and Freddie, but they even have lending standards and maximum loan values based on where the house is located you are trying to finance. There is no quick fix for a problem that has taken years to manifest itself. We as Americans have gotten really used to quick fixes for difficult problems. This time, I think we are all going to have to be patient and let the fundamentals of economics run its course.Case in point; John Doe borrower purchased a home in 2005 with an interest only, adjustable rate mortgage. That first mortgage was at an 80% LTV (loan to value ratio) on a home he purchased for $275,000. John Doe then had his mortgage broker secure second mortgage (home equity line of credit) for the additional 17% of the home’s value. This leaves John Doe having to bring $8250 US, plus some additional funds for closing costs, to the closing table.

The issue is that John Doe got this loan through a program that used to exist called a No Doc Loan. Another words, it was a loan based on stated income. Yep, you just told the mortgage broker what your income was, and they took your word for it. Your loan package sailed through underwriting and within 30 to 45 days, John moved into his dream home. Granted, John Doe had a pretty good credit score at the time; above 700, so he easily qualified for the loan because he made $150,000 a year as an IT Manager. So you are thinking; what’s the problem?

John Doe did not make $150,000 a year; he only made $99,000 a year. So, given a first mortgage of $220,000 at 5.75% and a second mortgage of $46,750 at a variable rate of prime plus 2% (around 8.75% at the time), his monthly payment for principal and interest would be approximately $1055 $341 $1396 Interest Only or approximately $1600 on a 30 year amortized basis. This does not take into account his escrow amounts for taxes and insurance, which would add about $225 a month to either payment. When you add in those figures and take into account his real salary of $99,000 a year, one can see that a payment of over $1800 a month for John is somewhat of a stretch, but he can manage it since he will either sell the house in a couple of years or refinance it in a couple of years into a fixed rate mortgage.

If you fast forward to now, John Doe is in trouble. The interest rate on his interest only loan has now is variable, he has a mountain of credit card debt, and his kids are going to college. The long and the short of it is; John Doe could not really afford the house when he bought it and he certainly cannot afford it now, no matter what sort of economic stimulus package the government passes. Even if he could talk his bank into re-amortizing his loan and dropping the interest rate to 0%, he most likely could still not afford the principal payments on the house, given his current economic situation and the fact that he cannot pull out equity from his house to pay off the other debt that he has amassed over the last three years.

This may sound like a far fetched scenario, but it is what is playing out across America at an alarming rate in many, many cases. Just look at the statistics that are released every month with regard to the foreclosure rates in the US. Furthermore, this same sort of scenario is starting to affect holders of jumbo mortgages, who have lost their jobs, and are straddled with a large mortgage payment.

There is not short term fix for this scenario and the entire real estate collapse that we have experienced in the US over the last year. It took several years to occur and it will take several years to balance out. It is a simple issue of supply and demand. There are too many houses on the market which puts downward pressure on home values across the board. Plus given the tighter lending standards, individuals cannot turn to their home equity to de-leverage themselves from the debt they have amassed.

Banks are lending, they are just not lending like they used to. Since cheap credit has dried up, they are relying on the old tried and true model of collecting deposits from their customers and then using those deposits to lend to credit worthy customers. There is no secondary market for mortgage paper currently except for Fannie and Freddie, but they even have lending standards and maximum loan values based on where the house is located you are trying to finance.

There is no quick fix for a problem that has taken years to manifest itself. We as Americans have gotten really used to quick fixes for difficult problems. This time, I think we are all going to have to be patient and let the fundamentals of economics run its course.< >< >

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