It is frightening to think that around two million subprime mortgages, worth around $350 billion, are expected to reset to a higher interest rate over the next 18 months. Meanwhile, resets on near-prime loans are expected to continue to climb until at least 2010. So, how can consumers work to avoid a crushing level of defaults by home owners who find themselves overextended?

Arnold Schwarzenegger, governor of California, has one idea that many other states may adopt. The strategy is based on the premise that foreclosures are expensive for banks, with the average one eating up more than 20 to 25 percent of the mortgage balance. As a result, it may be worthwhile for lenders to modify loan terms to be more accommodating. While this may reduce cash flows, it will likely mean fewer defaults.

This sounds good in theory, but some preliminary data is troubling. Some analysts have noted that 35 to 40 percent of modified loans still experience a re-default over the next two years. Obviously, this is due to interest rates that only continue to rise. So basically, in order for this strategy to work, interest rates would have to decline over the period of the re-negotiated rates in order to make the house as affordable as it was when the original mortgage was taken.

There is also concern that many consumers may view the process as unfair. After all, only those in a dire situation will be permitted to re-negotiate their loans to a lower rate despite their existing contracts in place. So, why should the government bail out the people who made dumb mistakes and spent above their means in the first place? It’s a good point that is likely to draw substantial criticism.

In the end, this strategy is likely to draw some heat while many doubt that it will work. However, there are very few other options for homeowners that are increasingly likely to default once their rates are reset higher. This will only compound the problems that we have already seen and send the market into a further tailspin. So, all we can do now is wait and hope…

Need debt settlement help? Call 866-559-DEBT (3328) today for a free consultation!