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During the first week of March 2008, President Obama’s plan to help families keep their homes has gotten rolling. The plan will help families by refinancing their mortgages to more favorable terms in an effort to stop the foreclosure situation in this country from spiraling further out of control.

The Housing Reform Plan has three key elements and divides homeowners into 4 distinct groups.

1. Those who own their homes "free and clear."
2. Those whose loan-to-value (LTV) is under 80%.
3. Those whose LTV is between 80% and 105%.
4. Those whose mortgage payments are an unreasonably high percentage of their income.

Group 1 includes 31% of homeowners and a lower total value of all of the housing (approximately 1/4).  This group is not in financial/foreclosure trouble.

Group 2 has an LTV that is not subject to receiving aid under this program.  That have the opportunity to refinance their current mortgages right now and are well-advised to do so, given that mortgage rates are at historic lows.

Group 3 is the core focus of the Housing Reform Plan.  The group with the LTV between 80% and 105%.  Despite likely having an LTV at 80% (or better) when they purchased the home and have been paying their mortgages faithfully during this time, the reality is - the early years of a mortgage don’t allow for a lot of that payment to go towards your principle.  It is primarily interest.  Under normal economic conditions or even with real estate values remaining static, the LTV may only be somewhere in the neighborhood of 75%.  However, in today’s economy, real estate values have plummeted substantially, in some of the largest metropolitan area - as much as 20%!  This backslide has driven LTVs much higher than could have been foreseen.  With these lofty LTVs, homeowners will not qualify for a refinance and that reality is what is driving the foreclosure crisis.

The reason that this magic number of 80% loan-to-value figure is important is because most banks won’t lend at levels that are higher than that.  You may be familiar with the usual requirement for a 20% down-payment on your home.  Most lenders require you to obtain private mortgage insurance (PMI) at figures above 80%.  This was also a requirement for the "GSEs" - which is the term given to those loans purchased or backed by Fannie Mae or Freddie Mac .

If Group 3 could refinance, they would save a lot of money each year.  For instance, a 1% reduction in your mortgage interest rate on a $200,000 loan would save approximately $2,000 per year.  This also takes a little bit of luck as your mortgage needs to be held/backed back Fannie or Freddie.  That’s about half of all mortgages out there and even though that is a requirement, over 4-million families stand to benefit from the reform plan.

Group 4 is comprised of those people close to foreclosure or already in foreclosure proceedings.  The program budgets about $75-billion and uses the GSEs and the Federal Housing Administration (FHA) in an effort to prevent foreclosures.  This group may have been sucked into ARMs with early teaser rates which have adjusted upward.  They may also be people who lied (committing mortgage fraud) by embellishing their income at the time they purchased their homes.  Of course, they may be also one of the untold numbers of people who have recently become unemployed.

The plan is directed only at owner-occupied homes.  Essentially, the existing mortgage holder would have to reduce the payment to 38% of the homeowner’s income, either by reducing the interest rate, extending the term, or by reducing the principal. So, if the homeowner was paying 45% of his income, the first 7% reduction would be on the bank alone. Then the cost to bring the payment down to 31% would be split 50-50 with the government.

In return for these initiatives, lenders would get $1,000 up front and $1,000 per year for 3 years for each mortgage they modified that stayed current. This is where the controversy of the plan lies.  Critics point out that it will tend to reward some homeowners that were irresponsible from the get-go - including those who lied on their original mortgage applications or who were banking on huge increases in their incomes in the future to afford the higher rates after their adjustable-rate mortgages reset.  Supporters contend that if the house next door falls into foreclosure, the value of your house falls significantly.  Multiply the number of foreclosed homes in your neighborhood by 3, 4, or more… and your home’s value will plummet substantially.  It is estimated that this program may help between 3 and 4 million homeowners.

The final element of the plan is to revise the bankruptcy code , so judges can modify the terms of mortgages when the homeowner declares bankruptcy. Lobbyists for the financial industry are irate about this proposal, but their cries scream of hypocrisy.  The priority of this administration is to try to do what is necessary to stop and ultimately reverse this financial debacle.  Currently, only primary residences are excluded from being revised by the judge. That, of course, is almost always the biggest debt that the person filing for bankruptcy has.

First American Corelogic reported that an estimated 8.3 million homes, or almost 25% of all homes with mortgages on them, are currently underwater. If housing prices fall another 5%, an additional 2.2 million homes will slip below the waves. Another 5% decline in home values nationwide is almost a certainty at this point, with a further decline of 10 to 15% highly likely.  That certainly puts this crisis in perspective.

The total value of all homes in the U.S. fell to $19.1 trillion at the end of 2008, from $21.5 trillion at the end of 2007. Half of the total decline in value was in the state of California. Now, not everyone that is underwater is likely to walk away from their house, but there are 2.2 million homes that are deep underwater, with LTV’s of more than 125%. Those folks are very likely to default, particularly if their mortgage payments are eating up most of what they make. These deep and medium-depth (more than 105% LTV) people are the final group and likely won’t be able to be rescued.

In short, this plan will not totally solve the mortgage problem, but it will significantly improve it. To the extent that the rate of foreclosures is slowed, it may have more impact on stabilizing the banks than all the cash that is being thrown at them directly.

Blame can been spread far and wide - on both the lenders and consumers.   The lenders were the ones who were supposed to be and act professionally.  They were the ones making the big dollars.  Unfortunately, some will unjustly benefit some to save the system.  It is far better to have some of the benefits go to the borrowers, rather than it all going to the lenders.