Looking at the legislative landscape, I see a new danger on the horizon.  In addition to the existant dangers of financing a mortgage for a buyer such as their credit-worthiness and ability to repay, there is another risk which could soon be inserted into the pool…

Cram-Downs

If you aren’t already familiar with the term, take a moment to read the definition…  From the perspective of a lender, it is a scary scenario.  In effect, a bankruptcy judge could force down the balance of a loan based on their view of the value of the property.

Regardless of whether the seller is in the first or second position, they could face financial danger in this situation.  While helping out the buyer and hoping to make a little extra money on the sale of their home, they could find their investment principal… in effect, having the base value of the loan reduced.

Congress is looking at allowing cram-downs in residential mortgages again.  It is the second time this year that the subject has come up.  Currently they are saying that the new rules would only apply to loans before January, 2009, and that there would be other safe-guards in place to protect the investments of the lenders.  And remember, the lenders aren’t actually the banks and mortgage brokers.  The lenders are investors… and that means that they range from school teachers (through their pensions) to corporate portfolios… and anyone else that has money in the MBS (Mortgage Backed Security) market.

For a look at how cram-down provisions affect mortgages, one only needs to look as far as the commercial mortgage market and compare it to residential.  In effect, rates are higher, down payment requirements are higher, reserve amounts are higher and credit is tighter.  Before the lenders are willing to part with their money, they need to be more sure that they will be paid back, because a judge could reduce the value of their investment if the borrower has a problem.

And getting a higher interest rate for the increased risk might not help… the same judge could reduce the interest rate prior to lowering the principal balance.

So, I am telling my sellers that they need to be MUCH more aware of the risks, and that those risks could increase if Congress gets too populist.

from GwinnettGarageGuy.com