Rate Freeze

The U.S. government saw the rising foreclosures in 2007 and decided to implement a rate freeze program to help relieve homeowners. It negotiated with many different mortgage service companies, including Countrywide Financial, Citigroup, Washington Mutual and Wells Fargo to create a program that would prevent mortgage rates on Adjustable Rate Mortgages (ARMs) from resetting to a higher rate.

The program was designed to not only benefit a targeted group of homeowners but also the economy as a whole by reducing foreclosures. After all, it is a deadly cycle that has been put into motion. The rapid number of foreclosures has caused a huge surplus in cheap housing; this led to a decline in housing prices; and this led to less equity for homeowners which resulted in even more foreclosures.

The program itself will involve having these banks set aside as many as 1.2 million loans and not reset the interest rates for at least five years to keep costs manageable for homeowners. There are a few rules, however, to keep people from gaming the system. First, the plan would only be available to owner-occupied properties, which leaves investors out to dry. Secondly, borrowers must be in relatively good standing with their current loan.

The problem with the system is that mortgage investors are being left out of the loop – and these are some very important people. The government went straight to mortgage companies to eliminate the rise in interest rates, which wouldn’t affect them at all. Instead, those investors holding the mortgage-backed securities will suffer substantial losses. Obviously, a lower interest rate for five years longer than expected is a problem when they were expecting to get much higher interest rates.

Many believe that the plan could end up hurting the mortgage industry by raising costs in the future. After all, investors that are now being hurt by the government have no insurance that they won’t do the same thing again in the future. So, their only choice is to raise the “risk premium” on the securities and charge future borrowers even more money. Moreover, the appetite for these types of loans in general could be significantly diminished.

Whether or not this was the right move by the government remains to be seen, but it is definitely a controversial program.