A Plan to Freeze Subprime Mortgage Interest Rates

A plan to help borrowers in subprime loans is in the works. It was revealed yesterday that the Bush Administration is working with major lenders to freeze interest rates on subprime mortgages. The freeze would be for an additional limited period and is not a permanent freeze.

Details are not readily available, since the plan has not been finalized yet. Here is what we know (from the Balitmore Sun):

The rescue package targets adjustable-rate subprime loans for owner-occupied homes, not loans for investment properties. Eligible homeowners must be current on their payments and face costly resets that they can’t afford. How they must prove that they can’t afford the higher rates hasn’t been revealed.

The plan would be voluntary for lenders, but the banks involved in the discussions hold, directly or indirectly, about four out of every five subprime adjustable-rate mortgages, or ARMS.

Temporarily freezing interest rates has always seemed to be the most sensible way to combat the problem. At least until the market comes back to its senses and we have a normal real estate market. From the banks perspective, you’re losing money either way.

If the rate adjusts and the homeowner can’t afford the house, then the bank looses money. The bank will also lose some money by freezing rates. But I would imagine freezing rates would be the cheaper option. and hence better of two evils. The banks participating in the meeting seem to understand this:

“I think there is a basic assumption here that there is money that is going to be lost one way or the other,” said Wayne Abernathy, executive director of financial institution policy at the American Bankers Association.

It will be interesting to see how they determine who will benefit from the rate freeze, because the scale of this problem is quite big.

Wall Street analysts believe there are about 1.5 million subprime loans resetting next year, pushing the payment on a typical mortgage from $1,200 a month to $1,550. Federal regulators believe there are 2 million “exotic” ARMs that have low introductory teaser rates and that 30 percent of them are already behind on payments.

Related post: Regulators Urge Restructuring Loan Terms For Struggling Borrowers

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