When I worked as a loan collector at a bank, we would regularly see information about every loan in the account range to which we were assigned. This included the original and current balances, terms, collateral, debtor info, resources (i.e. income) upon which repayment was based, and timeliness of payments.
One day my colleague had a new loan show up for a 20-something person that had a pricey new Corvette as collateral. To us collectors, the resources listed seemed far too meager for such a grand loan balance. It was unsurprising when the first payment came in late. Each subsequent payment was increasingly late until the loan was two months in arrears before it was five months old.
In this case, the delinquent debtor sold the Corvette and paid the entire sales price on the loan. But the car had lost more value in its young life than the decline in the loan balance over the same period. This meant that the young debtor ended up taking out a signature loan for the balance. A signature loan is a no-collateral loan with a high interest rate.
By the time this small loan was paid off two years later, the five-month lark with the sports car had exacted a very steep price from this young person. Not only had the debtor been taught a painful lesson, the loan officer received some counseling about the matter as well.
When you get a car loan, you agree in the contract that the collateral is worth the amount being loaned, and that you will make the specified payments on schedule regardless of what happens to the value of the collateral. Most contracts specify that if the collateral falls below a certain percentage of the loan balance, the lender may raise the rate to reflect the increased risk they are taking or may require immediate payment of the full balance. (That usually happens via refinancing, but not always.)
What happens when a person incurs a house loan for which he has insufficient resources to repay? In the past, it has usually meant selling the home or having the loan foreclosed on. Today it is estimated that some nine million home occupiers (I hesitate to use the term homeowner) have outstanding loan balances that significantly exceed both the value of the home they occupy and their ability to repay the loan.
To make matters worse, many of these people couldn’t sell their home for any reasonable price, due to market conditions generally and locally. The remaining option for these people is foreclosure. Most of them would end up renting for years to come, but it is possible that some of them could actually afford to buy a lower tier foreclosed home.
Politicians eager to appear compassionate have decided to thwart this market mechanism in multiple ways, beginning last fall. (Since they bear some culpability in the matter, some action may be warranted.) The latest $75 billion (could end up being as much as $85 billion) installment would permanently enslave many people in homes they still won’t be able to afford and in which they likely will never develop equity. It will be like renting, but with shackles that prevent them from looking for other rental options. The banks and the government will be the de facto landlords, but without the rights that regular landlords enjoy.
If this latest plan were applied to cars, the Corvette buyer mentioned above would have been forced to keep the Corvette instead of getting into something more affordable. Also, if you think renters are bad, people that feel like they’re over a barrel and stuck in a home in which they have no equity are famously horrid at caring for the place. So, not only will their more responsible neighbors be forced to help keep them in an unaffordable home, these same neighbors will see their property values decline due to the ill kept homes in the neighborhood.
Instead of putting taxpayer money into a plan that tries to keep people shackled to homes they can’t afford and that they don’t own, a better program would be to help these people transition to more affordable dwellings and liquidate the vacated homes at rates the market will bear. This would not be without pain to individuals and institutions, but it would be better than what we are doing.