When the Treasury Secretary announced in a recent speech that the Hope Now coalition is working on an ambitious plan to freeze interest rates on qualified mortgages, the mood among homeowners who could be positively affected surely was upbeat. Hope Now is an alliance of community, government and industry groups in search of viable solutions to the subprime mess. The aim is to rewrite eligible adjustable rate mortgages, or ARMs, so that when they reset, borrowers won't be burdened with unaffordable payments.
After a mortgage is issued, it typically is sold to the secondary market where it could be repackaged and sold again. Most of these debt obligations end up in the portfolios of large-scale investors, like pension funds and international entities. It is this sector of the vast mortgage market that is cool to the freeze proposal.
They have a good reason to be so. Upon buying these securities, they were guaranteed a certain rate of return and it would be against their particular objectives to give it up. A rate freeze would undoubtedly do that, cut deeply into their profits.
Mortgage servicers act as middlemen between borrowers and investors. They receive the payments and then forward monies to the investors according to the contract terms that exist between them. These contracts generally allow the servicers to rework up to five percent of loans within a particular batch, while going over that limit requires an approval. Hope Now draft appears to exceed this cap across the board. Therefore, without the investor consent the proposal has a considerable hurdle to climb.
Should the plan go forward, though, how would the investors be compensated for their losses? That's what they are worried about. The obvious answer is to reach into the taxpayer's pocket and that would amount to a federal government bailout. Rather unpopular undertaking among the large majority of the country.
Moreover, the investor community is now faced with the fact the U.S. government can intervene in the marketplace whenever it feels like and amend executed contracts to their detriment. They will accept that, but since this will add more risk to the debt obligations, they will require more return. More yield. As a result, mortgage rates will move higher for the home buyer.