Allowing Underwater Borrowers to Refinance - Brad DeLong

Richard Green (August 2011):

Richard's Real Estate and Urban Economics Blog: Allowing underwater borrowers to refinance could help: Yves Smith and Adam Levitin, for whom I have enormous respect, argue that allowing underwater borrowers to refinance their mortgages at lower rates would not help the housing market very much.? I am not so sure.

Consider a borrower?with a six percent mortgage whose house is worth 80 percent of the mortgage balance.? Let's also say that it is four years into its mortgage--so it has 26 years remaining on its term.? If house prices remain flat, it will be 11 years and 9 months before the mortgage balance drops to the value of the house.?

Suppose we were to convert the mortgage to a 4.5 percent mortgage but left the mortgage payment the same.? In the first month, the amount of principal payment would increase by 2.35 fold.? The borrower would be above water in 5 years and 5 months (I have a spreadsheet with the calculations, should anyone be interested).? If house prices rise by two percent per year, the 4.5 percent borrower would be right-side up in less than four years.? Helping borrower see a light at the end of the tunnel could really make a difference (I don't see borrower in Las Vegas ever seeing that light, but not everyone is in Las Vegas).

Personally, I would rather see some principal reduction too, but allowing free refinancings on Fannie and Freddie mortgages could materially benefit the housing market.

Source: http://delong.typepad.com/sdj/2012/11/richards-real-estate-and-urban-economics-blog-allowing-underwater-borrowers-to-refinance-could-help.html

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