The program includes annual payments to the lenders of up to 1000 for approving the modification and additional bonuses if the homeowners are still in their home five years from now. Investors need not apply. As long as your mortgage is owned by Fannie Mae or Freddie Mac they will even reduce your principal to get you into the program.

Under this program, interest rates can go as low as 2% to get the payments down to an affordable 2% of the family income.

Here’s the Treasury department summary of the program:

Homeowner Affordability and Stability Plan

Executive Summary

Read the Homeowner Affordability and Stability Plan Fact Sheet HERE
Read Support Under the Homeowner Affordability and Stability Plan: Three Cases HERE

The deep contraction in the economy and in the housing market has created devastating consequences for homeowners and communities throughout the country.

* Millions of responsible families who make their monthly payments and fulfill their obligations have seen their property values fall, and are now unable to refinance at lower mortgage rates.

* Millions of workers have lost their jobs or had their hours cut back, are now struggling to stay current on their mortgage payments – with nearly 6 million households facing possible foreclosure.

* Neighborhoods are struggling, as each foreclosed home reduces nearby property values by as much as 9 percent.

1.
Refinancing for Up to 4 to 5 Million Responsible Homeowners to Make Their Mortgages More Affordable

2.
A $75 Billion Homeowner Stability Initiative to Reach Up to 3 to 4 Million At-Risk Homeowners

3.
Supporting Low Mortgage Rates By Strengthening Confidence in Fannie Mae and Freddie Mac

The Homeowner Affordability and Stability Plan is part of the President’s broad, comprehensive strategy to get the economy back on track. The plan will help up to 7 to 9 million families restructure or refinance their mortgages to avoid foreclosure. In doing so, the plan not only helps responsible homeowners on the verge of defaulting, but prevents neighborhoods and communities from being pulled over the edge too, as defaults and foreclosures contribute to falling home values, failing local businesses, and lost jobs. The key components of the Homeowner Affordability and Stability Plan are:

1. Affordability: Provide Access to Low-Cost Refinancing for Responsible Homeowners Suffering From Falling Home Prices

· Enabling Up to 4 to 5 Million Responsible Homeowners to Refinance: Mortgage rates are currently at historically low levels, providing homeowners with the opportunity to reduce their monthly payments by refinancing. But under current rules, most families who owe more than 80 percent of the value of their homes have a difficult time refinancing. Yet millions of responsible homeowners who put money down and made their mortgage payments on time have – through no fault of their own – seen the value of their homes drop low enough to make them unable to access these lower rates. As a result, the Obama Administration is announcing a new program that will help as many as 4 to 5 million responsible homeowners who took out conforming loans owned or guaranteed by Fannie Mae or Freddie Mac to refinance through those two institutions.

· Reducing Monthly Payments: For many families, a low-cost refinancing could reduce mortgage payments by thousands of dollars per year:

o Consider a family that took out a 30-year fixed rate mortgage of $207,000 with an interest rate of 6.50% on a house worth $260,000 at the time. Today, that family has about $200,000 remaining on their mortgage, but the value of that home has fallen 15 percent to $221,000 – making them ineligible for today’s low interest rates that now generally require the borrower to have 20 percent home equity. Under this refinancing plan, that family could refinance to a rate near 5.16% – reducing their annual payments by over $2,300.

2. Stability: Create A $75 Billion Homeowner Stability Initiative to Reach Up to 3 to 4 Million At-Risk Homeowners

* Helping Hard-Pressed Homeowners Stay in their Homes: This initiative is intended to reach millions of responsible homeowners who are struggling to afford their mortgage payments because of the current recession, yet cannot sell their homes because prices have fallen so significantly. Millions of hard-working families have seen their mortgage payments rise to 40 or even 50 percent of their monthly income – particularly those who received subprime and exotic loans with exploding terms and hidden fees. The Homeowner Stability Initiative helps those who commit to make reasonable monthly mortgage payments to stay in their homes – providing families with security and neighborhoods with stability.

* No Aid for Speculators: This initiative will go solely to helping homeowners who commit to make payments to stay in their home – it will not aid speculators or house flippers.

* Protecting Neighborhoods: This plan will also help to stabilize home prices for all homeowners in a neighborhood. When a home goes into foreclosure, the entire neighborhood is hurt. The average homeowner could see his or her home value stabilized against declines in price by as much as $6,000 relative to what it would otherwise be absent the Homeowner Stability Initiative.

* Providing Support for Responsible Homeowners: Because loan modifications are more likely to succeed if they are made before a borrower misses a payment, the plan will include households at risk of imminent default despite being current on their mortgage payments.

* Providing Loan Modifications to Bring Monthly Payments to Sustainable Levels: The Homeowner Stability Initiative has a simple goal: reduce the amount homeowners owe per month to sustainable levels. Using money allocated under the Financial Stability Plan and the full strength of Fannie Mae and Freddie Mac, this program has several key components:

+ A Shared Effort to Reduce Monthly Payments: For a sample household with payments adding up to 43 percent of his monthly income, the lender would first be responsible for bringing down interest rates so that the borrower’s monthly mortgage payment is no more than 38 percent of his or her income. Next, the initiative would match further reductions in interest payments dollar-for-dollar with the lender to bring that ratio down to 31 percent. If that borrower had a $220,000 mortgage, that could mean a reduction in monthly payments by over $400. That lower interest rate must be kept in place for five years, after which it could gradually be stepped up to the conforming loan rate in place at the time of the modification. Lenders will also be able to bring down monthly payments by reducing the principal owed on the mortgage, with Treasury sharing in the costs.

+ “Pay for Success” Incentives to Servicers: Servicers will receive an up-front fee of $1,000 for each eligible modification meeting guidelines established under this initiative. They will also receive “pay for success” fees – awarded monthly as long as the borrower stays current on the loan – of up to $1,000 each year for three years.

+ Incentives to Help Borrowers Stay Current: To provide an extra incentive for borrowers to keep paying on time, the initiative will provide a monthly balance reduction payment that goes straight towards reducing the principal balance of the mortgage loan. As long as a borrower stays current on his or her loan, he or she can get up to $1,000 each year for five years.

+ Reaching Borrowers Early: To keep lenders focused on reaching borrowers who are trying their best to stay current on their mortgages, an incentive payment of $500 will be paid to servicers, and an incentive payment of $1,500 will be paid to mortgage holders, if they modify at-risk loans before the borrower falls behind.

+ Home Price Decline Reserve Payments: To encourage lenders to modify more mortgages and enable more families to keep their homes, the Administration — together with the FDIC — has developed an innovative partial guarantee initiative. The insurance fund – to be created by the Treasury Department at a size of up to $10 billion – will be designed to discourage lenders from opting to foreclose on mortgages that could be viable now out of fear that home prices will fall even further later on. Holders of mortgages modified under the program would be provided with an additional insurance payment on each modified loan, linked to declines in the home price index.

* Institute Clear and Consistent Guidelines for Loan Modifications: Treasury will develop uniform guidance for loan modifications across the mortgage industry, working closely with the bank agencies and building on the FDIC’s pioneering work. The Guidelines will be used for the Administration’s new foreclosure prevention plan. Moreover, all financial institutions receiving Financial Stability Plan financial assistance going forward will be required to implement loan modification plans consistent with Treasury Guidance. Fannie Mae and Freddie Mac will use these guidelines for loans that they own or guarantee, and the Administration will work with regulators and other federal and state agencies to implement these guidelines across the entire mortgage market. The agencies will seek to apply these guidelines when permissible and appropriate to all loans owned or guaranteed by the federal government, including those owned or guaranteed by Ginnie Mae, the Federal Housing Administration, Treasury, the Federal Reserve, the FDIC, Veterans’ Affairs and the Department of Agriculture.

* Other Comprehensive Measures to Reduce Foreclosure and Strengthen Communities

o

Require Strong Oversight, Reporting and Quarterly Meetings with Treasury, the FDIC, the Federal Reserve and HUD to Monitor Performance

o

Allow Judicial Modifications of Home Mortgages During Bankruptcy for Borrowers Who Have Run Out of Options

o

Provide $1.5 Billion in Relocation and Other Forms of Assistance to Renters Displaced by Foreclosure and $2 Billion in Neighborhood Stabilization Funds

o

Improve the Flexibility of Hope for Homeowners and Other FHA Programs to Modify and Refinance At-Risk Borrowers

3. Supporting Low Mortgage Rates By Strengthening Confidence in Fannie Mae and Freddie Mac:

* Ensuring Strength and Security of the Mortgage Market: Today, using funds already authorized in 2008 by Congress for this purpose, the Treasury Department is increasing its funding commitment to Fannie Mae and Freddie Mac to ensure the strength and security of the mortgage market and to help maintain mortgage affordability.

o Provide Forward-Looking Confidence: The increased funding will enable Fannie Mae and Freddie Mac to carry out ambitious efforts to ensure mortgage affordability for responsible homeowners, and provide forward-looking confidence in the mortgage market.

o Treasury is increasing its Preferred Stock Purchase Agreements to $200 billion each from their original level of $100 billion each.

* Promoting Stability and Liquidity: In addition, the Treasury Department will continue to purchase Fannie Mae and Freddie Mac mortgage-backed securities to promote stability and liquidity in the marketplace.
* Increasing The Size of Mortgage Portfolios: To ensure that Fannie Mae and Freddie Mac can continue to provide assistance in addressing problems in the housing market, Treasury will also be increasing the size of the GSEs’ retained mortgage portfolios allowed under the agreements – by $50 billion to $900 billion – along with corresponding increases in the allowable debt outstanding.
* Support State Housing Finance Agencies: The Administration will work with Fannie Mae and Freddie Mac to support state housing finance agencies in serving homebuyers.
* No EESA or Financial Stability Plan Money: The $200 billion in funding commitments are being made under the Housing and Economic Recovery Act and do not use any money from the Financial Stability Plan or Emergency Economic Stabilization Act/TARP.

August 14, 2008
MORTGAGEE LETTER 2008-21

TO: ALL APPROVED MORTGAGEES

ATTENTION: Single Family Servicing Managers

SUBJECT: FHA Loss Mitigation Program Updates

The Federal Housing Administration (FHA) is pleased to announce several changes to its Loss Mitigation Program that will strengthen both the Loan Modification and Partial Claim Initiatives.

While these changes are designed to address borrowers who are facing serious defaults, most delinquencies can and should be resolved through early intervention. Mortgagees are reminded of the critical importance of early and constructive contact with delinquent borrowers and the requirement to notify borrowers of the availability of default counseling by HUD-approved counseling agencies.

Loss Mitigation Program Changes

This Mortgagee Letter announces three changes to the existing Loss Mitigation program designed to give mortgagees additional latitude to help borrowers cure defaults and retain homeownership. The changes noted below are effective immediately.

First, with respect to Loan Modifications, mortgagees may use the Treasury 10-year constant maturity as a basis for establishing the maximum interest rate for loan modifications. The maximum interest allowable should be calculated as 200 basis points above the monthly average yield on United States Treasury Securities, adjusted to a constant maturity of 10 years. Mortgagees shall refer to the rate that is in effect as of the date of execution of the loan modification. For information on the 10-year monthly constant maturities, please refer to the statistical release H.15, which is available on the following web site: http://www.federalreserve.gov/releases/h15/data.htm

Next, where loss mitigation is being attempted after foreclosure has been initiated, mortgage servicers and mortgagors have advised that foreclosure related costs and legal fees are often impediments to successful loss mitigation. Many mortgagors who are able to resume making monthly mortgage payments frequently do not have sufficient funds to reimburse the mortgagee the legal fees and foreclosure costs incurred prior to qualifying for loss mitigation and therefore are denied participation.

Effective with this Mortgagee Letter, the Department will begin allowing legal fees and foreclosure costs related to a canceled foreclosure action to be incorporated into either the Loan Modification or the Partial Claim subject to the following requirements. This guidance expands and supersedes, in relevant part, the guidance provided in Loan Modifications section F (page 21) and Partial Claims section F (page 26) of Mortgagee Letter 00-05.

For Loan Modifications, legal fees and related foreclosure costs may now be capitalized into the modified principal balance. For Partial Claims (PC), mortgagees may now include legal fees and foreclosure costs related to a canceled foreclosure in the Partial Claim.

Mortgagees are reminded that all such foreclosure costs must reflect work actually completed to the date of the foreclosure cancellation and the attorney fees should not be in excess of the fee schedule that HUD has identified as customary and reasonable for FHA claim reimbursement. Late fees should not be capitalized in a Modification or included in a Partial Claim. As the goal in providing the mortgagor either a Loan Modification or a Partial Claim is to bring the delinquent mortgage current and give the mortgagor a new start, the mortgagee should waive all accrued late fees.

Please refer to Mortgagee Letter 2005-30 (or any subsequent guidance issued by FHA on reasonable and customary foreclosure costs) for the fee schedule for legal fees that HUD has identified as customary and reasonable for FHA claim reimbursement. Lenders should perform a retroactive escrow analysis at the time of the loan modification to ensure that the delinquent payments being capitalized reflect the actual escrow requirements required for those months capitalized.

Finally, in response to the industry’s request to provide adequate time for the mortgagee to complete all required actions related to a loan modification, the Department provides the following clarification. When establishing a loan modification, it is acceptable for mortgagees to include all payments due including an additional month in the loan modification.

Consider the following example. The mortgagor is due for the January 2008 and all subsequent payments. The mortgagee completes its loss mitigation evaluation on June 27, 2008. To allow adequate time to complete the loan modification, obtain all required signatures and provide adequate notice to the mortgagor of the new payment, the mortgagee may include the payments due for July 2008 and August 2008 in the loan modification. The mortgagor will begin remitting payments due under the modified mortgage effective with the installment due September 1, 2008.

Any questions regarding this Mortgagee Letter or requirements for use of the partial claim and loan modification authorities may be directed to HUD’s National Servicing Center (NSC) at 888-297-8685 or hsg-lossmit@hud.gov.

Sincerely,

Brian D. Montgomery
Assistant Secretary for Housing -
Federal Housing Commissioner

Here are some examples of how costs might differ if you refinanced your home mortgage loan.

Case 1: California

600,000 home, purchased in 2004, with a 450,000 mortgage at 5.625
Currently paying: $2,590.45/month.
Principal: $599.34
Interest: $1,991.11
Current Loan Balance: $424,171.84

What’s left: 424,000 plus 383,000 in interest over 26 years.

If you Refinance for 30 years at 5.30, here’s what you would face:
Monthly Payment: $2,354.49
Monthly Principal: $481.82
Monthly Interest: $1,872.67
What’s left: 424,000 plus 424,000 in interest over 30 years.

You get to drop your monthly payments, but because the loan is stretching out over an extra four years, you end up paying an extra 41000 in interest over the life of the loan. Plus you have any additional closing costs and refinancing costs to put the new loan in place.

If you instead continued to make your payments at 2590 per month, at the new interest rates, you would pay of the loan in 292 months, about 24 years and spend a total of 424000 plus 331,000 in interest. a net savings of over 50,000 from the original loan and almost 100000 over the new loan.

Here’s a page with some mortgage calculators from Homecomings.Com. As part of GMAC they just got bailed out and have plenty of money to spend.

If you find yourself five years into a thirty year mortgage and lenders start dangling lower interest rates, is it worth it to bite? Well it depends on your circumstance, but sometimes it isn’t. Many mortgages are front loaded on interest payment. It is only when you are five or six years into the loan that you start to see significant principal paydown. It is often possible to put yourself in a worse position to swap to a nominally lower interest loan if you are going to face higher fees and costs up front and put yourself back into a position of paying mostly interest in the first few years of the new note.

Here’s a timely article from the New York Times on the subject:

Because the typical mortgage only lasts for about five or six years before the homeowner sells the home or refinances the loan, lenders collect much of the mortgage interest during those years. Once a loan gets beyond five or six years old, homeowners can start seeing the overall debt drop at a faster pace.

So if a homeowner has reached that point, does it make sense to start a new 30-year loan, and face another five years where you’ll make heavier interest payments? The answer, as is so often the case with financial decisions, depends on individual circumstances. If retirement or tuition payment plans involve the liquidation of a home, it may make sense not to take out a new loan.

But in other cases, the monthly savings from a cheaper mortgage could be critical — “especially in this economy,” said Richard E. Austin, a financial adviser with Lincoln Financial Advisors.

Mr. Austin, who is based in Rye Brook, N.Y., noted that someone who five years ago borrowed $220,000 on a 30-year, fixed-rate mortgage at 5.5 percent would have reduced the loan principal to only $203,500, despite having made nearly $75,000 in payments during that time. From this point forward, the principal would shrink more quickly, but if the borrower could reduce the interest rate to, say, 5 percent, the monthly mortgage payment would drop by $157, to $1,092. Assuming it costs $3,000 to close that new loan, it would take just 27 months to recoup the costs if the borrower is in the 28 percent tax bracket.

If a homeowner planned on keeping the new loan for 27 months or longer, a refinance could well make sense, Mr. Austin and other mortgage advisers said. The federal government has floated the idea of engineering a 4.5 percent mortgage rate, by promising to buy mortgages at those rates, but that proposal was only targeted at loans made for a home purchase, not a refinance. Mortgage rates in late December were at their lowest level since at least 1971, when Freddie Mac began tracking these loans.

Closing costs vary widely in the New York area. Borrowers in Manhattan, for instance, face much higher mortgage taxes than those in the suburbs, so the financial calculus of a refinance decision shifts accordingly.

Mr. Austin, who is also a tax lawyer, said another frequently overlooked factor could help reduce the cost of a refinancing. If the new bank agreed to essentially absorb the old loan — albeit with new terms — the homeowner might not face a mortgage origination tax on the new loan. So when shopping for the new loan, he said, borrowers should ask if the lender will perform a “consolidation and assignment” with the old loan. Be sure to ask, or the lender may not offer it.

For those averse to the idea of starting the 30-year clock anew, Mr. Austin suggests splitting the monthly payment — making half at the middle of the month and saving the other half for the actual due date. That strategy, he said, can take years off the new loan’s payoff term.

Another cost savings strategy is to negotiate a new lower mortgage, but continue to pay the old rate. If you have 2500 monthly payment with 300 dollars going to principal, and reduce your required payment to 2200 but continued to pay 2500 you would in effect double the amount of principal you are repaying and could take many years off of the length of the mortgage.

Here’s the circumstance: if you fall far enough behind on paying your federal income taxes, either personally, or as a small businessperson, the IRS can file a Tax Lien against all of your personal property. That includes your house. And that tax lien takes precedence over your mortgage. That means the IRS can seize your home and sell it to cover your tax debt. If there isn’t enough money to pay back the lender, they are just out of luck. Unfortunately, that means no lender will want to carry a mortgage on your home. Which means you can’t possibly refinance your way out of an exploding mortgage and into a nice new safe mortgage.

Today the IRS announced that they are willing to “subordinate” their lien to your mortgage. If the house gets sold, the lender is protected and gets to go first. The IRS has over 1 million current tax liens against US residents, so a lot of families got a load of relief today.

Read more about the story here at the Journal or here in the IRS Newsroom

More room to fall?

For every $100 spent on a house in 1950 the investment rose slightly through 2002, then soared to about $192 in 2006, adjusting for inflation. Then credit dried up, and the bust began.

Rick Wallick moved into a new, three-bedroom $200,000 home in Maricopa, Ariz., in October 2005. Today, the home is worth $80,000.

The disabled software engineer stopped making mortgage payments this month. His $70,000 down payment is now worthless. His dream house will be foreclosed on next year.

“We’re so far underwater it’s not funny,” says Wallick, 57, who had to return to his original home in Oregon to care for a sick family member and tend to his own medical problems. Wallick, one of the hardest-hit victims in one of the states hit hardest by the housing crisis, lost 60% of his home’s value in three years.

His story is an extreme example, but home values have fallen so sharply since hitting a historic peak in the spring of 2006 that many Americans are wondering how much more prices can sink.

As painful as the decline has been, history suggests home values still may have a long way to drop and may take decades to return to the heights of 2½ years ago.

“We will never see these prices again in our lifetime, when you adjust for inflation,” says Peter Schiff, president of investment firm Euro Pacific Capital of Darien, Conn. “These were lifetime peaks.”

The boom in home prices — fueled by heavily leveraged loans built on low or even no down payments — made it easy to forget that housing values had been remarkably stable for a half-century after World War II, rising at roughly the same pace as income and inflation. Prices soared in most of the country — especially in Arizona, California, Florida and Nevada and metro areas of Washington, D.C., and New York — during a brief period of easy lending, especially from 2002 to 2006. That era’s over.

So far, home values nationally have tumbled an average of 19% from their peak. As bad as that is, prices would need to fall as least 17% more to reach their traditional relationship to household income, according to a USA TODAY analysis of home prices since 1950. In that scenario, a $300,000 house in 2006 could be worth about $200,000 when real estate prices hit bottom.

The price plunge has wiped out trillions of dollars in home equity and caused the worst financial crisis since the Great Depression. Susan Wachter, professor of real estate at the University of Pennsylvania, fears that foreclosures and tight credit could send home prices falling to the point that millions of families and thousands of banks are thrust into insolvency.

“Homes are different than other goods and services,” she says. “The fragility of our banking system is tied to the value of homes.”

Home values have fallen before — during the Great Depression and in Texas after a 1980s oil boom, for example — but those drops were a response to other economic forces. This time, the housing price collapse is the cause of the nation’s broad economic troubles, not just an effect.

“If we have another 20% decline in prices, we’ll need another bailout of banks similar to what we just did,” Wachter says.

Other economists see a brighter picture in the long term. Wachovia economist Adam York expects home values to keep falling until 2010 but is optimistic they will recover.

“The one saving grace is the population is growing by 3 million people a year,” he says. “They need to live somewhere. That means more roofs.”

Until recently, homes were stable, unspectacular investments, not get-rich-quick schemes.

Nationally, the typical existing home was worth roughly the same in 2000 as it was in 1950, after adjusting for inflation, according to Yale University economist Robert Shiller.

Newly built homes generally were bigger and more expensive than older houses. As time passed, that meant Americans lived in larger, more valuable homes overall. But a house, once constructed, grew slowly in value. California in the 1970s, Texas in the 1980s and Florida on-and-off for a century were conspicuous exceptions to the rule.

Despite only modest increases in value, homes were smart investments. Owners lived in a house, then got their money back when they sold. That’s a better deal than renting. Borrowers got tax breaks, too, and built equity that could be leveraged into bigger houses as their incomes grew.

From 2002 to 2006, houses went from being a tortoise to a hare in the investment world. Home sale profits and relaxed lending standards such as lower down payment requirements and adjustable-rate mortgages (ARMs) made it possible for buyers of all income levels to pay more for houses.

When the housing bubble began to deflate in 2006, history had a sobering lesson to teach. Home values had closely tracked three common-sense measures for many years:

•Income — Home values floated at about three times average household income from 1950 to 2000. In 2006, the average household income was $66,500. Under the traditional model, home prices should have been about $200,000. Instead, the typical home sold for $301,000.

•Rent — Homes traditionally have sold for about 20 times what it would cost to rent them for a year. In 2006, houses were selling for 32 times annual rent.

•Appreciation — Existing homes grew in value by less than 0.5% per year, after adjusting for inflation, from 1950 to 2000. From 2000 to 2006, home prices rose at an average annualized rate of 8.2% above inflation and peaked with a 12.3% jump in 2005. Housing prices began to fall in the second quarter of 2006.

Inflation could help homes recapture their old prices, if not their value. But when inflation is factored in, home prices might not return to their 2006 peak for many years. Housing prices are meaningless if you don’t adjust for inflation, says Schiff, the investment manager.

He points out that gold peaked in 1980 at $850 an ounce in response to inflation and the Iranian hostage crisis. It never recovered. Today, it sells for about $750 an ounce and would have to top $2,000 an ounce when adjusted for inflation to match its value in 1980.

“That’s the nature of bubbles,” Schiff says. “The price never comes back.”

An extreme relaxation of lending standards inflated the housing bubble.

“Shoddy underwriting on mortgages” is the primary cause of the housing crisis, says York, the Wachovia economist. “People got caught off-guard by how bad it was.”

Millions of home buyers — poor, rich and middle class — were approved to buy homes at prices that had been out-of-reach just a few years earlier. Lenders offered low introductory “teaser” rates on adjustable rate mortgages and approved borrowers based on artificially low mortgage payments, not the higher ones that took effect later.

What else changed:

•Optional payments on principal — In 2005, 29% of new mortgages allowed borrowers to pay interest only — not principal — or pay less than the interest due and add the cost to the principal. That was up from 1% in 2001, according to Credit Suisse, an investment bank.

• No verification of income — Half of mortgages generated in 2006 required no or minimal documentation of household income, reports Credit Suisse.

•Tiny down payments — In 1989, the average down payment for first-time home buyers was 10%, reports the National Association of Realtors. In 2007, it was 2%.

Low down payments and ARMs gave homeowners enormous financial leverage to pay high home prices. Leverage boosts buying power through debt, the same way a 100-pound woman uses a lever to jack up a 3,000-pound car.

Consider a couple with $20,000 cash. In 2006, they easily could get a 5% down mortgage to buy a $400,000 house. Today, a 10% down payment would limit the couple to a $200,000 house.

“Leverage matters a lot when you buy a house,” says University of Wisconsin economist Morris Davis, an expert on housing prices and rents. “We’re not going to go back to the days of only 20% (down payment) mortgages, but the days of putting nothing down are long gone.”

Easy access to borrowed money reset all housing prices, even those paid by cautious borrowers. People of all income classes moved up a notch, Census Bureau housing data show.

The sale of new homes costing $750,000 or more quadrupled from 2002 to 2006. The construction of inexpensive homes costing $125,000 or less fell by two-thirds. The biggest boom was in the middle. Homes costing $200,000 to $300,000 became affordable to millions of families.

The failed titans of home lending — Countrywide Financial, IndyMac Bank and Washington Mutual — specialized in high-risk, highly leveraged loans.

“The price correction has been severe, rapid and probably permanent because lending standards have changed,” says mortgage credit analyst Suzanne Mistretta, a senior director at Fitch Ratings, a bond rating company. “We are not going to see 2006 peak levels for a very, very long time.”

The Great Depression of the 1930s was preceded by a real estate bubble, also fueled by loose lending standards and shrinking down payment requirements. Those real estate problems — and solutions — echo today’s.

Florida real estate was the epicenter of speculation in the mid-1920s. Developers ran up prices by selling to borrowers who put as little as 10% down. Those were shockingly risky loans at a time when the standard mortgage lasted five years and required a 50% down payment.

The risky loans went bad first, but it was the spread of credit problems to the supposedly safe loans — five years and 50% down — that caused the housing market to collapse.

The five-year loans required no payments to reduce principal. Homeowners expected to refinance mortgages when the loans expired, usually with the same lender. The stock market crash led to a “liquidity crisis” — no money to borrow — that dried up mortgage refinancing.

Millions of families lost their homes to foreclosure. Falling prices on nearly everything — homes, farm crops, wages — made consumers reluctant to buy and banks afraid to lend.

As part of the New Deal, the government took control of millions of loans and restructured them into something new: the modern mortgage, with 20% down and principal that is repaid over the life of the loan. The government extended the mortgages to 15 years, then 25 and finally 30.

When World War II ended in 1945 and the Baby Boom began the following year, the 30-year, fixed-rate mortgage became a cornerstone of society and led to unprecedented levels of homeownership.

This resilient home finance system should recover in a few years, some analysts say.

National Association of Realtors chief economist Lawrence Yun predicts home prices will keep falling in 2009 but could return to their 2006 peak in three years, not counting inflation.

He says the bubble largely was confined to four states — California, Nevada, Florida and Arizona. “People who bought at the peak in those states will need time for prices to recover, even up to five years,” he says. Yun says people who buy now “have much less risk of price declines and a great possibility of price gains.”

The danger of rapidly falling home prices is that — similar to the Depression — potential buyers and lenders will stay away, fueling even sharper price declines.

During the housing boom, buyers expected prices to rise, so they were quick to buy, borrow and pay a premium. As prices drop, home buyers wait for better deals. says economist Dean Baker of the liberal Center for Economic Policy Research in Washington, D.C.

Lenders want bigger down payments to protect against the falling value of collateral. Homeowners lose equity, so they can’t buy other houses. “Price declines can be a self-reinforcing mechanism,” Wachter says.

An out-of-control price collapse would have dire consequences, Baker says. Even the most conservative banks would find themselves carrying portfolios of toxic mortgage loans.

If housing prices don’t stabilize at traditional levels, financial troubles could spread everywhere — to credit cards, car loans and commercial mortgages, Baker says. “The waves of bad debt will just keep coming,” he says.

Baker and Wachter want the U.S. government to take aggressive steps to help homeowners, not just financial institutions. They support expanding programs that restructure troubled mortgages to prevent a flood of foreclosed homes from coming on the market and driving prices below their traditional level.

Rick Wallick is an example of how even cautious borrowers can be hurt by a price collapse. He made a 35% down payment on his house and got a 15-year, fixed-rate mortgage at 5.75%.

Arizona’s real estate mess wiped him out anyway. Now that he’s in Oregon, he’s renting out his Arizona house at a loss and can’t afford to keep two homes.

Wallick’s Arizona house is surrounded by countless foreclosed homes and empty lots. He told his mortgage company that his December payment will be his last. “It may ruin my credit rating, but I can still buy food,” he says.

Shelley McComb used a no-money-down, interest-only ARM to pay $199,000 in December 2006 for a new three-bedroom home near Birmingham, Ala. The house’s assessed value briefly rose to $225,000.

Now, she needs to move to Atlanta where her husband got a promotion. The McCombs put their home up for sale in March. After getting no offers, they dropped their price to $179,000. They’d settle for $160,000.

Shelley McComb, 30, who manages a doggie day care center, says, “I wish we’d rented.”

Nov. 20 (Bloomberg) — Fannie Mae and Freddie Mac, the mortgage-finance companies seized by the U.S. government, will suspend foreclosures and evictions over the holidays.

The six-week halt will begin Nov. 26, a day before the U.S. Thanksgiving holiday, and last through Jan. 9, the companies said in separate statements today. The hiatus is designed to give servicers more time to implement a streamlined loan modification program for struggling borrowers.

“It’s a giant time out,” Paul Miller, an analyst at FBR Capital Markets in Arlington, Virginia, said today in a Bloomberg Television interview. “I wouldn’t be surprised to see this across the board.”

Fannie and Freddie, government-sponsored enterprises that own or guarantee $5.2 trillion of the $12 trillion U.S. home mortgage market, were placed under federal control Sept. 6. They have since been pushed to work harder at modifying troubled single-family and multifamily mortgages to curtail foreclosures.

Until a streamlined modification program is up and running, “we felt it was in the best interest of both borrowers and Fannie Mae to take this extra step to ensure that homeowners with the desire and ability to prevent foreclosure have an opportunity to stay in their homes,” Fannie Chief Executive Officer Herb Allison said in a statement.

Fannie and Freddie have partnered with HOPE Now, a government-organized coalition of the largest U.S. mortgage servicing companies, to offer borrowers who are at least 90 days delinquent and have high loan-to-income ratios the chance to modify mortgage terms to cut their monthly mortgage payments.

Incremental Steps

The companies plan to reduce interest rates for up to five years and lengthen repayment terms to as much as 40 years to trim monthly payments to roughly 38 percent of a homeowner’s monthly pretax salary. In some cases, borrowers may qualify to temporarily reduce the principal amount of the loan, which would be due without interest if the house is sold or refinanced.

“The Hope Now program is not going to be enough. It’s an incremental step,” said housing advocate John Taylor, president and chief executive officer of the National Community Reinvestment Coalition in Washington. “Obviously, we’re pleased that they’re doing this, but absent a substantive foreclosure program, I wonder if this is this just another problem they’re leaving for the Obama administration.”

Fannie and Freddie posted record third-quarter net losses totaling $54.3 billion last week. Freddie said it needs $13.8 billion from the U.S. Treasury by Nov. 29 to stay solvent, and Fannie said it may need federal aid early next year. Treasury Secretary Henry Paulson set up $200 billion in backup financing for Fannie and Freddie in September, saying the companies were failing and threatened the safety of the broader U.S. economy without federal intervention.

Foreclosures

The worst U.S. housing slump since the 1930s is being compounded by a recession that began in the third quarter and may last a year or more, according to Jay Brinkmann, chief economist for the Mortgage Bankers Association. Home prices in 20 U.S. metropolitan areas fell in July at the fastest pace on record, and sales of previously owned homes in August were 32 percent below the peak reached in September 2005.

A total of 765,558 U.S. properties received default notices, which warns of a pending auction, or were foreclosed on in the third quarter, the most since records began in January 2005, according to default data from Irvine, California-based RealtyTrak. Filings rose 3 percent from the second quarter and fell 12 percent in September from August as state laws created to keep people in homes slowed the pace of defaults.