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Fannie and Freddie Resist Reducing Principals: Report Suggests Pilot Program

by Amy Lillard

(04/10/2012) Nearly 1 in 4 homeowners are underwater, owing more than their home is worth. More than 7 million homes are still in the foreclosure pipeline. The housing slump shows no signs of stopping.

For this and other reasons, a growing number of economists, investors, academics, and consumer advocates are calling for organized principal reduction as the most cost-effective way to avoid the pain and pricetag of foreclosure for certain borrowers. But Fannie Mae and Freddie Mac, the two biggest mortgage finance companies in the country, are resisting this move.

A report issued by the Center for American Progress on March 29 revealed that the two government-controlled mortgage giants, which own or guarantee more than 3 million underwater mortgages, have a rule against lowering principals on loans, a rule issued by their regulator, the Federal Housing Finance Agency (FHFA).

The FHFA has thus far refused to change their stance, citing analyses that suggest other forms of relief like loan modifications are better for borrowers and taxpayers. However, increasing numbers of housing experts, private analysts, and even the Obama Administration, cite other statistics and reports indicating that forgiving principal balances is necessary for stabilizing the market and limiting foreclosures.

The report was a public step into this fray, and included a proposal for a principal reduction pilot program.

The goal, according to the Center for American Progress, is to avoid another huge wave of foreclosures, and the disastrous impact they have on borrowers and the general economy. Principal reductions are effective for deeply underwater borrowers facing long-term hardship, those borrowers who can’t justify making expensive monthly payments on an investment that has turned sour. But with more equity in their homes, statistics show, homeowners are more likely to continue with their mortgage and avoid delinquency.

The proposal program would entail “shared appreciation” modifications. Fannie or Freddie would agree to write down principals on deeply underwater loans. In exchange, borrowers would provide a portion of the future appreciation on the home. Both sides would benefit, contends the report authors.

The borrowers that would benefit the most, and that would make most sense from a broad economic perspective, would be decided loan by loan. But the authors suggest borrowers that:
  • Have a mortgage that’s worth at least 115 percent of the home’s current value
  • Are either delinquent on their mortgage payments or at imminent risk of default
  • Face a long-term economic hardship, such as a nontemporary decrease in income or permanent increase in unavoidable spending
  • Do not have private mortgage insurance or a second lien, such as a home equity loan

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