Bankruptcy & Foreclosures

We often talk about the economy and its current phase of inflated prices, a decreasing US dollar value, and oil prices that have Americans rethinking distances they travel but the world still turns meaning one way or another, individuals are forced to make ends meet. So how then are hundreds of thousands of people coming up with money they simply do not have? For some the idea of borrowing the money from themselves makes sense.

Enter the hardship withdrawal, a loan whereby a consumer takes a chunk of change out of their 401(k) or similar retirement plan. The idea of course being that perhaps the money would be of more use now than it would later as mortgages need to be paid, credit card bills continue to pile, groceries are getting more expensive by the minute and we don’t need to get into what oil’s been doing.

These withdrawals aren’t simply free money, however, and follow the rules of any other loan. This money is taxed as income as far as the government’s concerned and distribution penalties (as high as 10%) can be tacked on if the borrower is under 59 and ½ years of age.

That’s not all though, others chose to take out a single loan against their retirement, which could worth up to $50,000 (or 50% of the total amount invested in the account, whichever works out to be less). Here’s the catch with this one, if the borrower happens to default on the loan it is instantly considered a withdrawal and the taxes and penalties we talked about above come calling.

In the end, these loans can result in a retirement that is tens of thousands of dollars shy of where it would be had the account remained untouched. What’s worse is that according to experts, the retirement savings amounts here in the US are already dangerously low even without taking money out to solve short-term finances. Estimates have been calculated as high as nearly 50% of middle-aged Americans risk being unable to maintain the standard of living in retirement as in their working years as it is.

Keep in mind that many employers match contributions to your 401(k) account meaning that withdrawing money is actually costing the borrower twice in this situation. Once you account for the fact that the money is taxed as income, the benefits of borrowing from one’s self begin to lose their appeal.

A while back I posted with the interesting news that part of the stipulation associated with receiving our economic stimulus tax rebate checks was that we were told to spend them. Without delving too deeply on the whole theory of economics, the reasoning is simply that spending money frivolously could give our stagnant economic waters a little push.

Now for the disturbing news: With oil prices continuing to climb to record highs, many Americans are literally dumping their rebate down the tubes. Not to insinuate that we won’t all immensely enjoy using this bonus check on an integral ingredient to the internal combustion process, the real problem is that by purchasing fuel with our rebates, we are boosting an economy but not our own.

With gasoline averaging close to $3.75 per gallon and the average American good for just under 600 gallons per year, we’re looking at $2,250 per person in fuel costs for 2008 (assuming oil prices do not rise further). Compared to the $600 per individual rebate check, our bonus is a drop in the proverbial bucket (or in this case, a drop in the literal barrel).

The sad news is that even if we are able to convince ourselves that we are in fact spending our tax rebate check on domestic goods or services, the fact remains that we’re dropping alarming figures on fueling our cars, trucks, SUVs, and lawnmowers. Worse yet is that as a result of the rising fuel costs, nearly all areas of society are feeling the impact be it grocery costs, dining, clothing bills, etc.

So the bottom line is that until our government figures out how to lower the cost of oil, tax rebates and rate cuts are band-aid fixes to a much deeper national wound.

When the economy reaches levels where the light at the end of the housing crisis tunnel begins to fade, what choice to mortgage holders have but to turn to their government for help? As it turns out, Congress is ready, willing, and able to help more than a million homeowners staring down the barrel of potential foreclosure. The only problem is that their latest proposal is being met with skepticism in that it could worsen the current situation rather than improve upon it.

The plan calls for up to a whopping $300 billion in loan guarantees from the Federal Housing Administration to refinance loans that homeowners can’t afford under the stipulation that the original lender reduces the principal on the loan to 85% of the home’s current market value.

These measures aim to counteract the recent trend of home-price declines and it does have some redeeming qualities namely in the fact that lenders would get back more of their money than they would by foreclosing. Additionally in preventing 1.5 million foreclosures, this tactic would halt (or at least slow) home-price declines since it would keep these 1.5 million properties from flooding an already saturated market.

So what’s the problem you ask? Some critics claim that this plan would essentially transfer the risk to homeowners (mortgage holders) and lending institutions that were in fact cautious during the housing boom. Even more concrete is the reality that FHA would be left holding a massive portfolio of loans backed by houses and property worth less than the balances on the mortgages. You may say so what to these risks but think about it for a moment: Rather than banks and individuals facing foreclosure risk, the government itself (meaning each of us, the taxpayers) would be responsible for some 300 billion dollars in bad paper; This coming at a time when FHA’s losses are already at record highs.

The bottom line is that there is no easy solution to the crisis Americans currently face and regardless of how the numbers are shuffled; the burden of mortgages worth more than the property behind them isn’t going to simply go away. The Dodd-Frank bill is one of many yet to be approved proposals attempting to lessen the economical impact to the individuals in trouble with their mortgage but the fact remains that displacing the debt doesn’t make it go away.