Answering Ben's Call - A solution for the Mortgage Crisis

Ben Bernanke said today that we need new and creative thinking to fix the mortgage crisis. Well, I am a trader and investor and I am tired of this whole sub-prime fiasco messing up the rest of the market, so here is my outline for fixing this mess, using Mr. Bernanke's suggestions as a guideline. We need to have an adjustable principal mortage, similar to the adjustable rate mortgage. Here is how it would work.

1. The home owner would have an option to get a one time principal adjustment to their mortage. This would be available to anyone, but obviously only those that have seen a signficant decrease in market value would opt for this. There can be rules controlling what the minimum and maximum adjustment can be. The principal of the mortgage would be reset by basically deducting the difference between the original sale price of the house and the current appraised value from the current principal balance. The loan payment would then be reset based upon the new value, years remaining in the loan and whatever the interest of the loan is.

2. The principal would be adjusted a second time when the house is either sold or the mortgage is paid off. This second adjustment of principal could not be lower than the first, nor higher than the original principal of the loan. This prevents the home owner from profiting from the one time drop in the principal of the loan.

As an example, say you bought a house for $300,000 and financed the whole price. The market value is now $200,000. You opted for the one time principal reduction and your loan is reset to $200,000 and your mortgage payment drops accordingly. Five years from now, you sell the house for $225,000. Your mortgage pay off to the bank would be adjust to being $225,000 less the principal that you had paid down. If you sell the house for $325,000, your mortgage pay off is $300,000 less any paid down principal.

Lets say you do the one time reduction to $200,000 and then pay off that loan. At that time an appraisal would be done and you would either have to pay or execute a new loan for the difference. Lets say the market value is now $250,000, then you would have to have another loan for $50,000 and keeping on paying.

I don't know what all the tax ramifications are, nor how to actually execute this for existing loans given how they are packaged and sold. But it seems to me to be a better solution for banks than just letting people walk away from their house or be foreclosed on, and then write off the loss. There are losses to be taken still, but at least you still have the property occupied and people paying the loan and the potential of recouping the principal that you wrote off.