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December 09, 2008

Downsides of renegotiating mortgages

It's reported the government will now become directly involved in trying to change the terms of mortgages for homeowners having trouble making payments. This is obviously a tactic designed to try to stem the rising home foreclosures. But while such an action sounds good on the surface, are there any potential disadvantages associated with it?

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"Of course, we want to say that we certainly understand many households out there who are facing problems with paying their mortgages would welcome this kind of program. So we don't want to minimize that concern, but we did have a similar program during the 1930s, during the Great Depression, when the government stepped in and essentially forced lenders to renegotiate those mortgages. And it actually did help reduce foreclosures. But there was what I'll call a bitter aftertaste. There were some negatives later, because what happened once the economy got back on its feet is lenders remembered this. And they remembered that, gee, the government could come in and change the terms of this mortgage. There's a risk there, so what we saw happen was two negatives. We saw first of all, fewer lenders were willing to make mortgage loans, and secondly, the mortgage loans that were made carried a slightly higher interest rate, presumably to compensate for the risk that the government might come in and change the terms of that loan later. So with all kinds of government efforts to address the recession, we have to seriously consider what might be the possible later consequences."

Posted by Dave at December 9, 2008 08:00 AM