Allow principal reduction
Solutions to the foreclosure crisis will require many tools. Principal reduction should be one of them. Under the Home Affordable Modification Program (HAMP), modifications are offered only to families facing mortgage hardships when the net present value to investors of a modification is greater than allowing the property to go into foreclosure.
Since October 2010, HAMP servicers have been required to evaluate borrowers for principal reductions on loans not owned by Fannie Mae or Freddie Mac or insured by the FHA or VA. As a result, nearly 16% of HAMP modifications at the end of last year included some write-down of the loan balance. Banks reduce principal more than a quarter of the time for the mortgages they own. For them, the economics of principal reduction clearly make sense.
The current policy discussion is limited to whether this approach should be extended to Fannie Mae and Freddie Mac — whether they should offer principal reductions when it is more advantageous to them, and therefore taxpayers,
OPPOSING VIEW than alternative modifications or letting a home go into foreclosure.
Setting aside the question of basic fairness — two otherwise identically situated families can have wildly divergent outcomes solely based on where their mortgage ended up, which is entirely out of their hands — it runs counter to the goals of the agency that oversees Fannie and Freddie to preclude principal reduction. By its own preliminary analysis, allowing principal reduction would save Fannie and Freddie $1.7 billion compared with current practices.
Unlike forbearance, which leaves a lead balloon payment hanging over homeowners’ heads — due on sale or when the last mortgage payment is made — principal reduction doesn’t trap owners in their otherwise underwater properties. Over the long term, that looming balloon payment increases the likelihood of the borrower suffering another hardship, and another default.
Principal reduction can be a powerful way to reach sustainable modifications. Given the complexity of the housing crisis, we should approach it with a full toolbox.
Andrew Jakabovics is senior director of policy development and research at Enterprise Community Partners.