Modifying mortgages

One of the issues facing a large number of homeowners today is the fact that the value of their homes have fallen to a point where they are "underwater". This means they owe more than the house is actually worth. People in this situation have two choices, continue paying because, after all it is your home, and ignore the market, or, walk away from the mortgage and let the bank foreclose while you find housing that cost you less in rental or otherwise.

Faced with the high cost of foreclosures, especially in a time when the house is, in fact worth less than the mortgage and the market is glutted with foreclosures, there have been some suggestions that banks modify these mortgages downward. There is only one benefit in this for banks, the avoidance of foreclosure. While this may be a significant benefit, the unanswered question for bankers is, what if the mortgage gets written down and a loss recognized and then the value returns to previous levels? At this point the bank would have effectively provided a gift to the homeowner, the difference in equity between the reduced valuation and the value of the initial mortgage.

One solution that may or may not have been considered would be to put the written down amount plus accrued interest into a account to be recovered upon sale of the property. For example say there is an existing $400,000 mortgage on a property currently worth $300,000. Assuming the homeowner is a reasonable credit risk, the current payments are reduced to reflect a $300,000 mortgage. The remaining $100,000 is then put into a balloon payment amount that is due when the property is transferred. It occurs to me that the risk of loss could be shared at a some ratio, so for example, if the house eventually transferred for $350,000, the bank and homeowner could both benefit (perhaps and 80-20 split) so if the house valuation increased by $20,000 the homeowners share of this would be $$4,000. This would provide some motivation to the homeowner to maintain the property and share in price appreciation.

I see a large number of potential benefits to something like this, reduction of foreclosures, more cash available to consumers, and while income to the banks is reduced, the cash stream becomes more certain and they maintain the lost valuation as an asset.

Just a thought.