Principal forgiveness gains traction as a money saver

Fannie Mae and Freddie Mac could save $1.7 billion if they forgave principal on some distressed mortgages, a new analysis shows.

The Federal Housing Finance Agency — which regulates the mortgage giants — may decide in the next few weeks about whether to use principal forgiveness as a foreclosure prevention tactic, said Edward Demarco, acting director of the FHFA while speaking Tuesday at the Brookings Institution.

The FHFA, and Demarco, have come under pressure to allow Freddie and Fannie, which own or guarantee 60% of all home loans, to do principal forgiveness.

FHFA’S previous analysis has shown that forgiving mortgage debt is no more effective than other loan modification efforts at reducing home loan defaults — and could cost taxpayers more money since Freddie and Fannie were placed under government control in 2008.

But new incentives from the Treasury Department may change that, FHFA’S preliminary assessment shows. With those, Freddie and Fannie could curb losses by $9.9 billion if almost 700,000 homeowners received a mortgage reduction, FHFA says. That’s $1.7 billion more than if those homeowners received principal forbearance — which means they defer payment on a portion of their loan.

Demarco cautioned that any principal forgiveness would only help the U.S. housing crisis at the “margin,” given that 11 million homeowners owe more on their homes than they’re worth, based on Corelogic estimates.

He also warned that some homeowners might stop paying their mortgages to try to get a principal reduction. That could wipe out benefits to Freddie and Fannie. Also, Treasury incentives come from taxpayer funds, so taxpayers would still be “on the hook,” says Anthony Sanders, real estate finance professor at George Mason University.

Principal reduction “is clearly getting more traction” as a foreclosure prevention tactic, says Laurie Goodman, senior managing director of Amherst Securities. The recent $25 billion mortgage settlement requires loan servicers to do at least $10 billion in principal reduction. That doesn’t cover Freddie or Fannie loans.

Principal forgiveness supporters say it’ll lead to fewer foreclosures and help stabilize housing prices. FHFA’S new analysis — and Demarco’s discussion of it — signals that a change is likely, says Ira Rheingold of the National Association of Consumer Advocates.

Demarco is “under enormous heat from the Obama administration” to do so, Rheingold says.