4.5% 30 year fixed?

The latest plan from the government to stop the slide in home prices sounds better than most of the others. The idea is to offer gov backed low interest loans for purchases. This is something I thought they would eventually come up with. I don't see how helping underwater homeowners stay in a house they can't really afford will fix the economy. But offering lower interest loans to people that can actually afford a home will. This is one plan I can actually support. Now we just need to see if the banks will play ball. I wonder if the news of this plan will slow the buying down? I would certainly wait a while to find out if this happens.

WASHINGTON -- The Treasury Department is considering a plan to revitalize the U.S. home market that would push down interest rates for loans to purchase a home, according to people familiar with the matter.

The plan, which is in the development stage, would temporarily use the clout of mortgage giants Fannie Mae and Freddie Mac to encourage banks to lend at rates as low as 4.5%, more than a full point lower than prevailing rates for standard 30-year fixed-rate mortgages.

Government officials are under pressure to address falling home prices and mounting foreclosures, which underpin the financial crisis. The Treasury has struggled for months to come up with a plan that would ease the strains on borrowers without appearing to bail out homeowners and lenders.

The plan remains in discussion and may not be made final before the Bush administration's term ends in January. President-elect Barack Obama has said repeatedly that his administration would do more than the current one to help struggling homeowners but he has not offered specifics.

Treasury views this plan as potentially halting the slide in home prices by enabling borrowers to afford bigger loans, thus increasing demand and pushing up home values. The lower interest rates would be available only to borrowers who are buying a home, not those refinancing a mortgage.

Borrowers would have to qualify for a mortgage guaranteed by Fannie, Freddie or the Federal Housing Administration. Those guarantees apply to loans where borrowers can document their income and afford their monthly payments, steering the government away from backing loans considered risky.

The Treasury and the Federal Reserve are already working to bring mortgage rates down through a program announced last week in which the Fed will buy up to $600 billion of debt issued or backed by Fannie and Freddie, along with Ginnie Mae and the Federal Home Loan Banks. That move helped push down rates on 30-year mortgages, and applications to refinance have jumped, the Mortgage Bankers Association said Wednesday.

If this rate cut happens it will probably slow the price correction. People are payment oriented and a lower interest rate will allow then to buy a more expensive home.

If you can afford a payment of $2k per month but the home you want is $400k you are out of luck currently. At 6% you can only spend $334K to get a $2000/mo payment. But drop that rate to 4.5% and now you can spend $400k for the same $2000/mo payment.

The sad reality is that most people do buy based on monthly payments. It's far easier to swallow overpaying for a house if the payment is the same. Of course, you are stuck with an extra $700 a year in property tax for as long as you own the house. This would ultimately lead to a much longer period of price stagnation. Which is fine if the rates remain low. But if after a few years the banks jump the rates back up then we might find ourselves in another real estate downturn. Prices would have to fall again in order for monthly payments to remain affordable.

I do think this is a good idea. However I feel it will only work if the prices correct to sane levels. If the government is using this plan in the hopes of keeping prices high I think it will ultimately lead to another downturn or just stretch this one out another 10 years.