Using public money to buy down principle in underwater mortgages is a strategy to help banks. It is likely to do little or nothing to help underwater homeowners. In most cases these homeowners will still pay more in ownership costs each month than they would to rent a comparable unit. This is money that they could have otherwise used to meet other needs or to save for the future.
These homeowners are also unlikely to end up with any equity when they sell their homes, since the housing glut will continue to depress prices for the foreseeable future. By contrast, principle buydowns allow banks to collect far more money on their bad mortgages than would otherwise be the case. This NYT article implied that principle buy downs are a way to help homeowners.
[Addendum: If people really care about homeowners then they would include the "Baker option" in any buydown package. This would involve calculating the full amount of money that the government would be handing to the banks for principle writedowns or other concessions and then offering it to the homeowners with the understanding that they will lose the house. If the deal is being done for the benefit of homeowners and not banks, there is no reason not to offer the homeowners the same amount of money that the government is prepared to pay the banks.]
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