A new plan proposed by the FDIC Chairman might do away with the need for subprime borrowers to refinance their loans. Although her recommendation is radical, it could be beneficial for everyone concerned.

One of the country's most powerful banking industry executives has proposed a radical approach to help alleviate the subprime mortgage crisis. In a prepared statement delivered at an investment conference, Federal Deposit Insurance Corp. Chairman, Sheila Bair, suggested that lenders permanently freeze the interest rates on subprime adjustable-rate mortgages to help homeowners manage their payments without having to do a mortgage refinance.

Converting to a fixed rate

"Keep it at the starter rate. Convert it into a fixed rate. Make it permanent. And get on with it," Chairman Bair told her influential audience, according to CNN/Money.com. While her idea is drastic and would cost banks and mortgage companies huge amounts in the short run, it may save them from even greater financial catastrophe in the long run.

More than a million suprime loans with variable interest rates are scheduled to reset to higher rates over the next 12 to 18 months. As that happens, more and more homeowners will see their monthly payments increase. During the past year, for example, similar mortgage resets have caused payments to jump as much as 100 percent or more within one payment cycle.

Tightening the rules

When homeowners can't afford the unexpected higher payments, their first line of defense is to refinance into a more attractive and manageable loan. While mortgage refinance strategies have inspired an unprecedented number of new loan refinance applications, many of those attempts are now being met with rejection from lenders. That's because they've tightened their rules and regulations to curtail risk and offset losses. What that means for you is that it's much harder to get a loan than it used to be. Homeowners who had no trouble refinancing a couple of years ago may find that they don't qualify anymore under the new guidelines. With no way to refinance, they're stuck in mortgages that keep getting more expensive, even as real estate values shrink, and home equity diminishes or vanishes completely.

Blair recommended that the plan be applied only to help homeowners who live in their homes-not investors who bought property for investment purposes only. The approach would essentially accomplish the same thing that homeowners are hoping to achieve through a mortgage refinance, and could prevent hundreds of thousands-if not millions-of devastating foreclosures.

Saving grace

On the surface, her plan may sound too generous for lenders to embrace. But upon closer examination, it looks like an idea whose time has come, one that could potentially save lenders much more money than it will cost them if they don't take this kind of step. Every time a lender forecloses, it costs them a huge chunk of their initial investment. Letting borrowers keep their current rates to avoid massive numbers of foreclosures might turn out to be a saving grace for both lenders and homeowners alike.

Published on November 4, 2007