From Homescape

It’s a bird. It’s a plane. It’s … Henry Paulson? With payments about to soar with higher interest rates on some subprime loans, relief is on its way according to U.S. Treasury Secretary Henry Paulson.

The deal, which was hammered out between the White House and a coalition of lenders, mortgage servicers, and investor groups, was officially announced by Paulson and President Bush on Thursday. Under the plan, some subprime homeowners would see their rates frozen for five years, while others would get refinanced into more affordable mortgages or placed into loans backed by the Federal Housing Administration.

The plan, which is voluntary for the mortgage industry, targets homeowners who have been keeping up with payments. It also helps those who received loans with adjustable rate mortgages (ARMs) in 2005 through July 30 of this year and will face problems when their interest rates are scheduled to reset between January 1, 2008 and July 31, 2010. 

Freeze goes so far

The five-year freeze is limited. It excludes anyone who is more than 30 days late at the time the mortgage would be modified or anyone who has been more than 60 days late at any time within the previous 12 months. Borrowers have to be living in their home, so flippers that got in over their heads during the housing boom are shut out. People who can’t afford the loan even at low introductory rates also will be ineligible.

The interest rates of more than 2 million of these subprime loans are scheduled to jump — and jump a lot — over the next two years. Economists believe that as many as 500,000 of these loans could enter foreclosure. Of the perhaps 2 million subprime ARMs that are expected to reset through the end of 2009, only 240,000 of those would be covered by the freeze, according to an analysis made by investment bank Barclays Capital, as reported in The New York Times. 

People who entered subprime mortgages and got stuck with the hefty rates thought that they could refinance out of their loans before rates went up. But it didn’t work out that way, because the housing market nosedived and the value of their properties plummeted. The plan would give them a breather and keep their interest rates from rising, as they are scheduled to do.

Sounds good, right?

Some economists are arguing that loan modifications aren’t the real solution to the problem, and those borrowers already knee-deep in payments they can’t afford are just prolonging their foreclosure fate. Critics argue the plan will send the message that it’s OK to bite off more than you can chew, because the government will bail you out.

While there are mixed feelings from investors, some are happy because they will benefit from avoiding the cost of foreclosures, which are estimated at $50,000 per loan. The idea of conducting wholesale workouts with troubled borrowers was initially proposed in early October by Federal Deposit Insurance Corporation chief Sheila Bair. 

“The approach announced today is not a silver bullet,” said Paulson during the plan’s announcement Thursday. “We face a difficult problem for which there is no perfect solution.”

Thousands of borrowers who are falling behind on their payments have been sent letters explaining the options, and Bush also urged people to call a new hotline: 1-888-995-HOPE.

Does this plan reward bad behavior? Or is the plan necessary to slow the rising rate of homes projected to go into default in the next few years?