Why Not A Variable Principle Mortgage?

There can be a way for underwater mortgage holders not to walk away from their obligations and instead stay in their homes.

There even might be a way to exit our current mortgage mess, not just for home owners already in trouble, but also those merely struggling, and even some folks wishing to buy who can’t quite qualify for a loan – all without involving government beyond its usual roles of rule maker and referee.

That way involves inventing and adopting a new and more flexible kind of mortgage. Call it a Variable Principal Mortgage, or VPM.. Lenders could offer it as an additional alternative to more traditional instruments, both to new buyers and to owners needing to refinance.

A VPM would acknowledge up front that the risks and rewards of the housing market can be shared by both buyer and lender. The idea assumes that:

Home owners, now painfully aware that housing prices don’t rise forever and, in fact, can fall off a cliff, would willingly trade part of tomorrow’s potential gain for protection against falling values today and the possibility of a credit wrecking foreclosure.

Lenders in turn would trade a potential reduction in revenue today for a possible future equity payday, while avoiding the hassle and loss of  foreclosure.

Here’s how a VPM mortgage could work:

If the home value rises above the purchase price the gain is shared between borrower and lender when the house is sold..

If the home value drops below the purchase price the pain is shared, perhaps annually, by reducing both the total principal owed and the principal payment due each month.

If that lowered value then rises, phoenix-like, from its financial ashes, the total principal owned and the monthly payment would rise in tandem with it -- up to the numbers the parties started with.

So far, so good, but getting there from here won’t be easy. Before borrowers and lenders can sign on to the concept there are many questions to answer:

1) What ratios for sharing equity gains and losses would be fair? Could they vary over the life of the mortgage and under what conditions?

2) Realized gains are easy to measure: subtract the purchase price from the sales price.
Unrealized losses have to be estimated. How, how often and by whom?
3) Suppose the house is sold "underwater" after a number of years in which the original buyer has faithfully made all payments due the lender.  Do either or both have an implied equity in the property after the sale?  At what point does this process stop?
4) Do federal loan guarantee programs and conventional mortgage insurance policies have a role?

5) Suppose the borrower dies? The lender already plays a role at escrow proceedings; is it now a privileged player during probate?

6) Are there implications for the special treatment of principal residence capital gains by the IRS?

7) Is there reason to limit this type of mortgage to first mortgages, principal residences only or to a finite number of properties owned by one person or family?

8) Such mortgages could be sold but could they be securitized? Should they be securitized?

9) How are real estate brokerage commissions affected, if at all?

10) What about second homes?  For snowbirds?

These and no doubt other questions require careful answers, and as always, the devil is in the details. But the issues they raise do not appear unsolvable and with a little understanding and cooperation between those who look to government for utopian answers and those who abhor any governmental involvement at all in the private sector, a new partnership between home buyers and mortgage lenders could be crafted..

Is that too much to ask of our elected representatives and business leaders? Would we buy what they devise? Success is not certain in these polarized and acrimonious days, but one can hope.