A Mortgage Relief Plan Some Cannot Afford

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Reports in the press say that Bank of America (NYSE: BAC) will allow some people whose homes are in foreclosure to rent them from the bank. Under the “Mortgage to Lease” plan, homeowners would give their deeds to the bank and sign leases. The idea seems good on paper — if the former homeowners can afford the rent. In many instances, that will not be the case.

The Wall Street Journal says the plan initially will involve 1,000 homeowners. These people get will one-year leases with the option of an extension of two more years. The rents will be at market value, or perhaps less. It is not clear how the rent price will be set, but the renters must demonstrate that they can afford to pay it.

Not all mortgages are set up the same way, obviously. Some have constant rates and run over the course of 30 years. Others have “teaser” rates that began low and reset after three to five years. People who cannot afford a mortgage payment no matter what the form of the loan, the plan assumes, can afford to rent. That is a false assumption in many cases.

How will a bank determine whether a person can pay fair market rent, if that person cannot make a mortgage payment? This may be the program’s largest hurdle. Many people who have lost their ability to make home loan payments are out of work, work part time or are already swamped by debt — some of it because of second mortgages. It is too early to tell, but it seems that many homeowners cannot afford to rent their own homes, under the rules Bank of America is ready to set.

Even those who can afford the new program may not have an incentive to do so. A renter cannot create home equity, no matter how unlikely that may be in some real estate markets. The renter also loses any tax deduction afforded an owner. Some of the people who could handle the transition financially may elect to move on.

The bank’s motives still are not entirely clear, but it certainly is acting in its own interest. There are P&L and balance sheet consequences to holding foreclosed properties and selling them below market value. The rental program may be a way to control the pace of those foreclosures primarily, and not meant to give people the chance to remain where they live now.

The single strongest economic argument against the bank’s plan — which Bank of America may not care about — is that many economists believe that troubled home loans must be flushed through the real estate system as quickly as possible. Otherwise the drop in national home prices will drag on for years. Instead, they argue, the drop should be rapid and painful. At least that will permit the market to find a bottom. The Mortgage to Lease plan will delay that problem.

Set aside all of the economic arguments about the effects of foreclosures and the future of bank balance sheets. Many people who own homes in the early stages of foreclosure cannot afford to rent them.

Douglas A. McIntyre

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