The latest news from the real estate market is the subprime mortgage bailout agreed to by the lenders and the federal government. The question, of course, is whether is effectively saves the real estate market or simply delays the inevitable?
As you may know by now, the mortgage industry really overextended itself when it came to issuing loans. The primary culprit was in the subprime market where mortgage were issued time and again to borrowers that had no business borrowing such money given their credit history. This problem was big, but manageable. It soon became something bigger, however.
People began using subprime and teaser loans to buy above their means. These loans offered cheap financing upfront with rates increasing dramatically two to three years after the loans were issued. Although foreclosure rates have bad recently, they are nothing compared to what is coming over 2008 and 2009 when most of these loans reset their rates.
Facing economic disaster, the federal government and lenders have been hammering out a potential bailout program. An agreement has reached. It is essentially a method to buy time. Any subprime borrowers who took loans from January 1, 2005 through July of 2007 and are facing a resetting or interest rates from January 1, 2008 through July 1, 2010 qualify. So, what do they get? Time. Their rates are frozen for five years instead of being reset. The savings are in the billions of dollars, but really simply buy homeowners time.
But is buying time enough? This is really the ultimate question. Ironically, the answer is really dependent upon a bet. The lenders and federal government are betting the real estate market will turn around in the next five years. Prices will increase creating equity in the homes and giving homeowners room to either refinance out of the bad loans or sell their homes.
So, why is this an ironic solution? It is the very same be that was made by the homeowners that are now in trouble. The purchased their homes with the belief that the market would continue to grow and home values would continue to increase. They never intended to pay the increased mortgage payments when they reset. They intended to sell or just refinance.
This leads us to the inevitable question of whether the government is simply going down the same dead end path or not. Historically, there is nothing to guide us as this has never been tried before. It is difficult to imagine the housing market staying in the dumps for five full years, but there is no law of finance that says it can't. Ironically, only time will tell if this was a good move or just delayed the inevitable.
