Mortgage Restructuring Ideas

I've seen a variety of ideas for mitigating the mortgage repayment crisis. One of the most intriguing is this: in return for having the lender reduce the principal value of the loan to reflect the current estimated market value of the property, the borrower will forgo all future price appreciation on the property, assigning that instead to the lender.

Here's how this would work, in general terms. Say that a house was bought for $500,000 with 20% down and a mortgage for $400,000. Say that today the estimated value of the property has declined 40%, to $300,000. Assume also, for simplicity, that the borrower has not repaid any principal on the loan.

What if the lender agreed to the reduce the principal value of the loan to $300,000? If the house were sold at some future date for greater than that amount, the price appreciation over $300,000 would belong to the lender. Likewise, if the house changed hands through means other than a sale, such as through a gift or an inheritance, the lender would be entitled to the excess of the appraised value at that time over $300,000. The precise mechanics of how this transfer of funds would be achieved, whether through cash payment or through the origination of a new loan to the new owner, are open to discussion.

The borrower in this example would lose his $100,000 down payment. One might argue that, if the value of the property exceeds $400,000 at that future transaction date, the borrower should be entitled to at least part of the further appreciation, but capped at his down payment of $100,000. Another open question is whether the lender should be able to recoup interest on the $100,000 reduction in loan principal if the value of property has risen beyond $400,000. This is another detail for which there are several reasonable alternatives.

The packaging of mortgages into MBS or REMICs complicates the process, but legislators and regulators should be looking closely into means to deal with this problem. In all, it is better for the bond holders to get some return than none, which should reduce their resistance to restructuring the underlying mortgages. Banks who still hold their own loans, unfortunately, seem to be less than creative in dealing with those in trouble. Hopefully some sharp entrepreneurs in loan modification companies will lead the way.