There may soon be a new chapter added to the Obama economic plan; advisors are hammering out the details of a strategy to lower mortgage rates dramatically. The plan's target mortgage rates are expected to be well below 5 percent.

As the housing crisis continues, the forthcoming Obama administration is considering a new strategy for the formidable battle: driving mortgage rates into the ground.

New twist for the Obama economic plan

Treasury Secretary Henry Paulson is mulling over a plan to stimulate the housing market by lowering mortgage rates substantially. But more significantly, the Obama administration wants to hear more about it. Paulson's target mortgage rates are in the neighborhood of 4.5 percent, about 70 basis points lower than the national average mortgage rate as of mid-December.

Lowering mortgage rates to that level would reduce the cost of homeownership by trimming down the monthly mortgage payment. For example, at 5.2 percent, the monthly principal and interest payment on a $200,000, 30-year mortgage is about $1,098. But the payment on the same mortgage at 4.5 percent would be $1,013, roughly $85 cheaper. Reports indicate that with Obama's encouragement, development of the program is now being expedited.

Fannie and Freddie renewed

In its current form, the plan would use nationalized mortgage companies Fannie Mae and Freddie Mac to make the ultra low mortgage rates available to homebuyers. Fannie and Freddie would buy the low-rate mortgages from lenders, and pool those mortgages into securities, which would then be purchased by the federal government.

The plan's objective is to correct the longer-lasting impacts of the foreclosure crisis by using the lower rates to stimulate greater demand for home purchases. Luring in new buyers would put upward pressure on home prices and, hopefully, promote a healing of the housing market, which would be a small, but important step towards a broader economic recovery.

Since Paulson's vision doesn't involve offering the low rates on refinances, distressed homeowners wouldn't benefit directly from this plan.

Bigger picture

The current administration believes that offering the lower rates on refinances, as well as purchases, would increase the program's cost significantly, without providing a proportionate increase in benefit. Nicholas Strand, a mortgage analyst from Barclays Capital Inc., has estimated that a purchase-only program would cost $300 to $400 billion. But including refinances in the deal could send that price tag up to $3 trillion.

The Obama administration, however, will make the final call on whether to offer the low mortgage rates to existing homeowners. Some sources indicate that the President-elect favors a broader program, one that would provide direct assistance to everyone.

Published on January 13, 2009