Among the qualifications for the ARM rate freeze is that the homeowner must have a higher LTV than 97%. That’s more, not less. Thus only those who owe more than 97% of the value of their home can qualify. (And given some of the more exotic mortgages and dropping home prices, yes, you can owe more than 100%.)
The idea is to get people to keep making mortgage payments on a loan that is worth more than the collateral. A neat trick! If these “homeowners” really crunched the numbers, they would realize it’s better to walk away, and rent for less money, rather than to keep making the mortgage payment.
The plan is sold as helping homeowners. It is designed to help investors.
That would be those who bought CDOs and the like, bond-like products that contain thousands of mortgages. If enough of them default, then the CDO goes worthless and the bond insurance company has to pay up. Trouble is, many of those insurance companies are already wobbling badly. If one or more of them crater, then the effects on the financial system will be profound.
That’s the real aim of the plan, to postpone the inevitable collapse of billions of dollars worth of CDOs and SIVs. But if you bought your home in 2005 for $400,000 on a no-doc 1% down ARM loan and it is now valued at $350,000, you will be way underwater and indeed, it may be far more financially prudent to simply walk away from it.
However, not all investors are exactly thrilled with the plan
The only problem with the plan is that it may turn out that investors may try to refuse to be plundered.
And this appears to be only the opening scenes of Act 1. More carnage is coming, from “second mortgages, hybrid intermediate-term ARMS, and the soon-to-be infamous Pay Option ARM.”
During the Paulson Q&A on Friday, he was asked: “Do you anticipate bank failures like England saw with Northern Rock?” Paulson gave a non-answer, and the reason is probably because there are several bank failures in the offing.