With $676 Billion in Homeowner Negative Equity, Can McCain’s Plan Really Cost Only $300 Billion?

In the presidential debate last night, John McCain referenced his new plan to help alleviate problems in the real estate sector (that have since cascaded into the mortgage market and now the wider credit market). Essentially, McCain’s plan means that the government would purchase qualifying loans from the banks (at the cost of the current mortgage), re-issue new FHA-backed loans to homeowners (at the current market value of the home), and absorb the difference between the current mortgage and the current value (i.e., the amount of negative equity in the home).

McCain estimates that his plan may cost as much as $300 billion, which actually seems quite low given the amount of negative equity out there right now. According to Zillow estimates, at the end of Q2 2008, there was approximately $676 billion of negative equity across all U.S. single-family homes (of which there are about 84.5 million in the U.S.). This cumulative amount is composed of about 11.7 million single-family homes that are underwater and an average of about $58,000 in negative equity for each of these homes (median negative equity for homes underwater was about $33,000).

Here’s some more information about the plan itself:

To be eligible, homeowners must be delinquent in their payments already (or be likely to fall behind in the near future), must be living in the home (and it must be their primary residence) and they must prove their creditworthiness at the time of the original loan (which apparently translates into no falsifications on the original mortgage application and a substantial down payment at purchase time).

McCain’s current plan differs from the Hope for Homeowners program signed into law back in July which allowed for new FHA-backed loans to be given to homeowners who were underwater on their mortgages (loans at 90% of the current value of the home) and required lenders to absorb the difference between the current mortgage and current home value. In his current proposal, McCain apparently envisions taxpayers eating this difference.

It also differs from the Paulson plan signed into law last week, which allows for the purchase of mortgage-backed securities. Under the Paulson plan, lenders would get to unload the assets (via auctions) at prices far below their original value, but at prices greater than the markets are currently valuing them. But homeowners with underwater mortgages don’t get any direct relief. Instead, these homeowners, under this plan, benefit from the inflow of capital into the market which allows lenders to start to make loans again which, in turn, will allow some homeowners in trouble to refinance into a more sustainable mortgage.

While details of the McCain plan are still scarce, a few obvious issues with it are:

• It benefits those homeowners who assumed the most debt closest to the height of the real estate bubble.
• It could create an incentive for more homeowners to default since they could then qualify for a reduced mortgage versus having to continue paying on an underwater mortgage.
• It places the full burden of relief on taxpayers, but taxpayers get no potential upside benefit. The individual homeowners and lenders would be the ones to see benefits under this plan, and the government (and taxpayers) would take an immediate write-off. But under the Paulson plan, the government will hold onto those mortgages, and those assets will likely regain their value over the long-term, thus ultimately providing some benefit to taxpayers.

What are your thoughts?  Lots of debate happening today in the Economic Watch category of Zillow Discussions on this plan, the Fed rate cut, Obama’s tax plan and other topics…