It seems like you can't turn on the TV today without finding a financial expert debating whether the economy is in a slow down or a full-blown recession, much the same way that others debate whether certain physical symptoms are those of the flu or a cold. While it's helpful to correctly diagnose the illness, the bottom line is that if the patient feels bad, something must be administered to help him recover and recuperate. Much like these ailing patients, many homeowners holding various types of adjustable rate mortgages (ARMs) are facing their own problematic symptoms including job losses, declining home values, rising interest rates, and the possibilities of default and foreclosure. Regardless of their different symptoms, unless they have sufficient income and their homes' values exceed the outstanding principal balances on their mortgages, they cannot continue to pay off their ARMs once their loans adjust to a higher rate. These loans are what I refer to as "Broken ARMs," and we need to find a cure for them quickly.



One type of Broken ARM is the subprime ARM, which typically starts with a fixed rate of interest for two or three years and then adjusts thereafter every six months or so. Borrowers holding these mortgages saw a first adjustment that raised their rates up to 3% over their initial rate, and additional adjustments thereafter.

Another type of Broken ARM, the "pay option ARM," allowed borrowers to pay interest rates lower than the rates required under the terms of the promissory notes securing their mortgages, while the mortgage balances swelled to absorb the difference between the note rates and the pay rates. In many cases, these borrowers' loans increased to 115% of the original principal balance. To make matters worse, the:

- Original principal balances on both subprime and pay option ARMs were equal to or approaching 100% of the appraised values of the homes at the time the loans were made.

- Creditworthiness of these borrowers (their likelihood of paying back the loans) was such that they could have qualified for conventional loan products (as opposed to subprime or pay option ARMs) at the time the loans were made.

- Creditworthiness of the borrowers (their financial ability to pay back the loans) was accepted "as stated" rather than verified using traditional underwriting practices.

- And home values have since fallen 20% or more in many areas of the country.

This situation, often dubbed the subprime crisis, will continue for three or four years as various Broken ARMs come of age, and the loans will likely end up either in foreclosures, short sales or bankruptcies. That is, unless a solution is found that will completely address the issues once and for all without regard to default status of the borrower, capabilities of the servicer, and uncertainty as to its applicability. The plan must be for all homeowners who financed after 2003 into any one of the Broken ARM products and it may need to be extended to address some unsettling news in the conventional arena. Of paramount importance to any program is to realize that we have until the end of this year to address the relatively large loans widely-found in California, Florida, New York and other locations, thanks to the recently-passed Economic Stimulus Act and its increased loan limits. To date, we have tried FHA Secure, Hope Now Alliance, Project Lifeline and a few small scale programs. Read the papers, talk to industry experts, ask your neighbors. All nice tries, but they aren't doing the job. Nor will they ever.

Moreover, it's my feeling that any government sponsored plan will likely miss the point. While there are many bright, well-meaning politicians working to come up with something, they really don't understand the mortgage industry. It's really up to us, the men and women in the mortgage banking industry to come up the answer. We certainly had no problem working in concert with Wall Street and the borrowers over the last few years in framing this issue. The time has come to solve it. Others better equipped than I will work on assessing blame and controlling future mortgage trends. The job of this article is to propose a solution that can be embraced by all.

I call this solution "Appreciating America." It's a plan that should be adopted by all of the servicers, promoted to all of the ailing homeowners and supported by the US Government, especially the Federal Housing Administration (FHA). FHA has told me that the use of this solution would fit exactly within the current FHA guidelines. It's a fairly simple plan, which can be put into effect immediately since it utilizes time-tested mortgage programs used in the commercial arena, which are generally referred to as shared appreciation mortgages. I believe that this is what Chairman of the Federal Reserve, Ben Bernanke, was suggesting yesterday when he stated: "The fact that many troubled borrowers have little or no equity suggests that greater use of principal writedowns or short payoffs, perhaps with shared appreciation features, would be in the best interest of both the borrowers and lenders."(Italics added). I couldn't agree more.

Appreciating America works as follows:

- The homeowner refinances outstanding mortgages with an approved "Appreciating America Lender" in accordance with established FHA guidelines regarding loan-to-value (LTV) and debt-to-income ratios (DTI). The loan is fully supported by sufficient income, LTV limitations and tied to past mortgage payment history.

- The Appreciating America second mortgage is held by the current mortgage servicer and defers payments and interest. The homeowner and lender will share in the future appreciation of the home to pay off the Appreciating America second mortgage within five years.

- The new Appreciating America second mortgage is a subordinated second shared appreciation mortgage equal to the difference between the new FHA mortgage and the existing mortgage(s). This second shared appreciation mortgage will accrue interest at 6%, with payments deferred, and will not be payable until five years after the loan is made (or the home is sold). At that time, the homeowner has a choice of refinancing the mortgage(s) or selling the home.

- To the extent that the value of the home at that point is greater than the FHA first mortgage amount, the homeowner will first receive an amount equal to all capital improvements made to the property since the Appreciating America mortgage closed, and then the homeowner will receive 30% of the appreciation and the second mortgage holder will receive the lesser of 70% of the appreciation or the principal and accrued interest on the Appreciating America second mortgage. All appreciation in excess of the second mortgage balance including accrued interest shall belong to the homeowner.

The benefits of the Appreciating America plan are significant. Families will remain in their homes. With the promise of shared appreciation and protection of capital expenditures, the homeowner will be motivated to maintain and improve the property. The existing lender will not have to incur large losses in foreclosing or agreeing to a short sale in a dropping market. In fact, the servicer will receive the entire available proceeds from the new FHA mortgage as repayment on their original loan and may realize the remaining balance through future appreciation. Property values throughout the US should stabilize. Together, these benefits should have a positive impact on the US economy while protecting it from further property value erosion.

An example of this transaction is as follows:

- Original mortgage(s) = $200,000

- Current property value = $180,000

- Homeowner qualifies for a new $153,000 FHA first mortgage (up to 85% LTV, to include closing costs and FHA insurance premiums) with existing servicer taking a $47,000 (plus amount of closing costs and FHA insurance premium) shared appreciation Appreciating America second mortgage.

- Current mortgage holder(s) get immediate return of $153,000.

- The balance of $25,400 that the servicer is owed becomes a shared appreciation Appreciating America loan, secured by the property but with no payments due. Interest would accrue at a reasonable rate (6%).

- Property appreciates 3% per year over the next five years and is appraised at $209,000. Homeowner will qualify for a new FHA mortgage of approx. $203,000. The appreciation of $56,000 would be split with the homeowner getting $16,800 and the second mortgage holder receiving $39,200. The remaining principal balance owed on the second mortgage plus any accrued interest would be forgiven at that time.

The time is growing short and we need to act fast. The Office of Thrift Supervision suggested a variation of this, but included a new, untested feature that will absorb precious time in rolling out. Appreciating America works and works well. Debate is something that should always be encouraged except when it comes at the expense of millions of homeowners. The Broken ARMs need more than a band-aid. Appreciating America is the remedy that can work.

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