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Marley DelDuchetto/MEDILL
Homes like this foreclosed one in Kenwood might have been saved by a principal reduction.
Principal reduction: a lifesaver for underwater homeowners
by Marley DelDuchetto
Dec 06, 2012
Marley DelDuchetto/MEDILL
Foreclosed homes are intermingled with well-kept ones in Hyde Park.
Marley DelDuchetto/MEDILL
A dead body and two dead dogs were discovered in this foreclosed home on South Oakenwald Avenue.
Marley DelDuchetto/MEDILL
The boarded up windows of this foreclosed home are an eye sore for the rest of the homes on the block.
Principal reduction mortgage modification eligibility requirements under HAMP
· The mortgage was obtained on or before Jan. 1, 2009
· The mortgage is not owned by Fannie Mae or Freddie Mac
· Owe more than what the home is worth and the home is the primary residence
· Owner owes up to $729,750 on his/her primary residence or a single-unit rental property; up to $934,200 on a two-unit rental property; up to $1,129,250 on a 3-unit rental property; up to $1,403,400 on a 4-unit rental property
· The property has not been condemned
· Mortgage payment is more than 31 percent of owner’s pre-tax monthly income
· Owner has a financial hardship and is either delinquent on mortgage payments or in danger of becoming delinquent
· Owner has sufficient, proven income to afford reduced payments
· Owner must not have been convicted of a felony (larceny, theft, fraud or forgery, money laundering or tax evasion, in connection with a real estate transaction or mortgage) in the last 10 years
Mortgage modifications are becoming increasingly more prevalent in the U.S. as the housing market recovers. But it has taken a long time to get to this place. Rogers still believes the options available to homeowners are too limited.
“Too many people are excluded from modification eligibility and not enough people know about them,” Rogers said. “It is like a well-guarded secret.” He believes modifications need to be made easier and lenders need to reduce the amount some homeowners owe so they can keep their homes.
It’s called a principal reduction and it involves a lender, often a bank, “forgiving” a portion of what is owed on a home. The “forgiven” money is never collected and is not owed at a later date. It simply goes away. This type of reduction is only available to people who are seriously “underwater” on their mortgages, which means they owe significantly more on their home than its current value.
Many banks are currently doing non-principal reduction mortgage modifications that involve stretching out payments, deferring debt or lowering interest rates. But some experts say that is not enough.
Research shows that borrowers with principal reductions are four times less likely to re-default on their mortgages. The Federal Reserve Bank of New York published a 46-page report detailing its finding. Rogers, also a published researcher of mortgage modification, has findings that concur with the New York Fed’s report.
Of course, the housing crisis is not confined to the U.S. Many European countries are facing the same issue.
Ireland recently announced that it will be taking bold measures to help distressed homeowners. The Irish government is expected to pass into law this year an initiative called the Personal Insolvency Bill. The bill will lower borrower’s monthly payments and write down mortgages, a process that forgives a portion of the principal on the loan. The bill is intended to prevent a mass of foreclosure filings that has been looming over the country’s housing market for years.
Housing prices in Ireland are approximately 20 percent lower than in the U.S. and more than half of the country’s mortgages are underwater. While the new law does not require banks to reduce mortgage debt, it provides powerful incentives to do so.
While Rogers supports what Ireland is doing, calling it “spectacular”, some say following Ireland’s lead is not beneficial and even could be detrimental.
The Federal Housing Finance Agency and its officials believe principal reductions do more harm than good. Edward DeMarco, the director of the agency, said, “FHFA has concluded that the anticipated benefits do not outweigh the costs and risk.”
In a July press release, DeMarco announced he would not allow Fannie Mae and Freddie Mac, two government-backed companies that buy mortgage loans, to participate in the practice of offering principal reductions under the Home Affordable Modification Program, or HAMP. Several political-interest groups and politicians have since called for his firing over that stand.
HAMP is offered through the U.S. departments of Treasury and Housing and Urban Development. The program is open to homeowners who meet the eligibility requirements, which include having a mortgage of less than $729, 000 (see text box). Lenders are not required to participate in HAMP. However, HAMPS’s eligibility requirements are used as an industry standard for principal reductions.
“More than half of the mortgages in our country are immediately disqualified for principal reductions because they were issued by or are insured by a government agency,” Rogers said. “It’s unfortunate. The Federal Housing Administration, for example, was formed to help lower and middle class citizens achieve the American dream of home ownership and today, if you’re in trouble with your mortgage and your mortgage is insured by FHA, it is the American nightmare.”
Not surprisingly, the nation’s bankers aren’t crazy about principal reductions either. American Bankers Association spokesman Ryan Zagone says his group’s position “is the same as the FHFA’s.” Association CEO Frank Keating said, “Reductions are not some huge difference-making program that will rescue the housing market.”
Bob Davis, the association’s vice president of mortgage policy, agreed saying, “There are more cost-effective and efficient options that carry fewer unintended consequences than principal reductions.”
Only some of the FHFA’s research is publicly available. The FHFA declined to comment on its lack of transparency or provide additional research. “It defies any logic and they’re not sharing their findings with anyone,” Rogers said.
The most contentious issue looming over principal reductions is the so-called “moral hazard,” the idea that showing leniency to some will encourage others to act irresponsibly. “Principal reductions create an incentive for a huge group of borrowers who have continued making their payments, despite lower home prices, to stop paying in hopes of principal forgiveness,” says the ABA’s Keating. If reductions become available, people who do not actually need them will take advantage of the system, he warned.
Rogers agreed that moral hazard exists but said there are ways to combat it. One way would be to put an arbitrary date on when a borrower must have been delinquent to qualify so people cannot stop paying their mortgages one day in order to get a principal reduction the next.
“The fact is banks or the investors lose so much money in a foreclosure,” Rogers said. “It is really important to reduce foreclosures and reduce the re-default rate of modifications and that can only be done with principal reductions. The only problem is the moral hazard, but the potential benefits outweigh the moral hazard.”
Federal agencies may not currently allow principal reductions but in April 2012, the Department of Justice and 49 attorneys general reached a joint federal-state settlement called the National Mortgage Settlement.
In this settlement, the five largest mortgage servicers (Bank of America, Wells Fargo, JP Morgan Chase, Citi and Ally/GMAC) are required to offer some qualified borrowers principal reductions. The 49 state attorneys general anticipate this requirement will demonstrate to other servicers that principal reduction is an effective method in combating foreclosures and will not lead to an increase in mortgage re-defaults.
Rogers received three Bank of America principal reductions in the month after the settlement was reached.
“Principal reductions are spectacular for the borrower and the owner of the mortgage,” he said. “The more access homeowners can get to principal reductions, the less people we will become delinquent on their mortgages and have to file for foreclosure.”
