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May 14th, 2010

So This Is Why Principal Reductions Have Been Hard to Get

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Many borrowers aren’t qualifying for loan modifications. Even for the lucky ones who get approved, large percentages are redefaulting after only a short period. Why? The current strategies for modifying loans — extending the loan balance, reducing the interest rate and swapping out loan products — aren’t getting the job done.

The lack of permanent modifications has prompted cries for lenders to begin reducing the principal on troubled loans. While certainly controversial, underwater borrowers remain as the ball and chain around housing recovery’s ankle. That said, underwater borrowers haven’t had an easy go at getting their loan balances reduced.

According to CNNMoney.com, the reason why principal reductions have been so hard to get is because Fannie Mae and Freddie Mac have not been granting them:

Pressure is mounting on loan servicers and investors to reduce troubled homeowners’ loan balances…but the two largest owners of mortgages aren’t getting the message.

Fannie Mae and Freddie Mac, which are controlled by the federal government, do not lower the principal on the loans they back, instead opting for interest rate reductions and term extensions when modifying loans.

Fannie and Freddie’s Balancing Act

Both Fannie Mae and Freddie Mac are hemorrhaging cash. Just this week, the GSEs had to go back to Washington to ask for even more money:

If Fannie and Freddie lower homeowners’ loan balances, they are locking in losses because they have to write down the value of those mortgages. Essentially, that means using tax dollars to pay people’s mortgages.

On the flip side, loan modifications, and foreclosures for that matter, haven’t gained any positive ground. More and more underwater borrowers are bypassing home-preservation efforts and merely walking away from their mortgages. Even many of the home loans that have been modified are redefaulting.

So What’s the Answer?

Simply stated, many are saying — despite popular opinion — that it’s time to start reducing the principal balance on mortgages, at least for borrowers who live in markets where home-price declines are substantial. Furthermore, the analysts are saying that it may also help solve Fannie and Freddie’s loan mod redefault problem.

Readers: Are you for or against principal reductions?

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11 Responses to “So This Is Why Principal Reductions Have Been Hard to Get”

  1. Lucia Says: May 17th, 2010 at 8:49 pm

    1)Why are homeowners chosing to walk away? 2)Will principal reduction help them stay put? 3)Which is more helpful, staying put or moving away?

    If they are having an income crisis, then it might be more helpful to let them walk away so they can move in with relatives, move to another city, and generally make the changes which would help them make a new start. One of the problems of this recession is the immobility of the unemployed homeowners. Oh right, I forgot, the recession is over.

  2. Tim Manni Says: May 18th, 2010 at 8:41 am

    Lucia,

    From what I have learned, being underwater on their mortgage is the driving force behind walk aways. Borrowers see this mountain of negative equity that they think they can’t get back. As you alluded to, borrowers are making “a business decision,” deciding they will be better off financially by walking away and starting over; many times renting similar homes for far less each month. According to several experts, principal reductions are the answer (or at least one solution).

    Again, like you said, if the problem is a lack of income, how much will a PR improve that scenario? Can the recession be truly over when borrowers are still walking away from their loans and the unemployment rate is just shy of 10%?

    Thanks as always for your comments,
    Tim

  3. Rob Basichis Says: May 26th, 2010 at 2:35 pm

    Our organization can offer a Principle Reductions now. It is not credit based. You have to provide finacials and if you can afford the reduced mortgage you will qualify. In the process you never come off title. You are never asked to quitcalaim your ownership over to a third party. It is a clean deal that has been working for many homeowners who have gone through our system. If you live in an area like Nevada or Arizona where there has been severe depreciation and you are currently underwater please contact CBC Property Solutions by going ot our website. I dont’ see the virtue in wating around for the banks or the government to come up with a fair program that the average homeowner will qualify for. If they do come up with something it will more than likely be the same scam as the Loan Modification and the Mediation process which is a joke.

  4. phil Says: June 11th, 2010 at 8:56 am

    Although I am far from a financial expert, the only solution that makes sense to me is ‘Principal reductions’. I know the banks don’t want to do it, and since the Obama administration has no financial expertise themselves, they didn’t think through how temporary loan mods wouldn’t help. How could they give $75 B of our money away without any guidelines as to how they must use it. It just blows my mind!

    So any way, here we are, foreclosures will continue to grow, inventories will rise, and market values will continue to plummet. the only way to get values back up, is to reduce inventory, and start lending again. Guess what? The banks won’t lend because they don’t want more risk, and because the toxic loans they are sitting on ties up all of their available lending dollars. If the banks would take the “hit” on principal reductions, it would be costly to them, but they can at least get a write-off, apply for TARP funds, and start lending again. If they are lucky, they will recover 50 cents on the dollar in Foreclosure, versus 20-30 cents on a reduction. In foreclosure, its all a loss, but in a reduction, you still have a viable customer, who continues to earn you money on interest. Why does this seem so logical to me? This would stabilize inventory, and new lending, would continue to absorb more. One more thought. What if they gave a reduction, and the owner agreed to pay part of it back upon sale. This could be determined by current market value. Perhaps then, they aren’t as worried about people benefiting as the market values come back.

    i have been chasing “Chase” for 2 years, have done everything possible to honor my commitments to them, and because i have a job, and a good income, it doesn’t matter to them that i have negative cash flow every month, have drained my IRA to stay current (paid taxes on that), and used credit to pay for other bills, and household needs. Why? because I thought it was the right thing to do, and that I was a 30 yr customer of the bank, and that they would eventually take care of me. For fun, I just Fed Ex’d a letter to jamie Dimon (CEO), David Zulauf (CFO), and David Lowman (CEO Home Finance) with all of my brilliant suggestions. I’m sure it is the mail room somewhere, but it felt good to do any way.

  5. Tim Manni Says: June 11th, 2010 at 2:31 pm

    Hey Phil,

    Thanks for commenting. Here’s my take on principal reductions: if the deep-seeded problem is negative equity, and if borrowers are dealing with this upward financial battle by walking away, what else can cure a equity problem besides A) time and B) a reduction in principal?

    Thanks for commenting,
    Tim

  6. CAS Says: June 29th, 2010 at 2:19 pm

    If fannie and freedie arent doing principal reductions then what are they doing with the 75B? Modifing a 360k mortgage on a house that is now worth 170k, and sticking 190k into forbarence and giving the home owner, or should I say renter, a 190k ballon payment in 30 or 40 years shouldnt cost 75B.

  7. Tim Manni Says: June 29th, 2010 at 2:41 pm

    CAS,

    “what are they doing with the 75B?”: I really don’t know. But what I do know is that they’re losing money at an incredible rate. I just read an article from CNBC that says the following:

    “For American taxpayers, now on the hook for some $145 billion in housing losses connected to Fannie Mae and Freddie Mac loans, that amount could be just the tip of the iceberg.

    “According to the Congressional Budget Office, the losses could balloon to $400 billion. And if housing prices fall further, some experts caution, the cost to the taxpayer could hit as much as $1 trillion.”

  8. Fuzzy Says: July 7th, 2010 at 10:36 pm

    I think because Wall Street Fat cats got trillions of dollars out of these mortgage deals they should be liable.
    I don’t see anybody or any government agency questioning those who packaged the cdo’s as AAA packages to investors ever being questioned or held liable.
    The notes that people signed and were sold over and over again are worthless. These mortgage notes were signed on a promise that they will pay the mortgage note. These promises had no foundation and the only reason
    they were given to people was greed because a mortgage brokers and banks made big money, the banks made money, and those people who packaged them on wall street made big money by misleading investors. Everybody got their share, of big $$$ except the homeowner. They are stuck with a high mortgagehomeowners did not get a dime but those who sucked them into these deals are pocketed trillions of dollars. The Investors who bought these packaged mortgages are also lost everything. What I don’t understand is if THE INVESTOR LOST HIS MONEY ALREADY (it can happend in any investment) what are the servicers (BANKS) trying to collect and to whom? Banks already got their money from investors who they misled and later from the government :remember Henry Paulson’s big $870 billion bail out? Under GW Busch? Paulson sad. We need the money to help homeowners. Everybody forgot about that after Mr. Paulson got what he wanted.
    Also did you know: that every single mortgage which was in default was paid to the Banks by Insurance companies such as AIG and others, many times over? Because all these mortgages were insured in case of default.

  9. anselmo Says: December 27th, 2010 at 10:39 pm

    I see this article was written in May 2010 and comments up to July 2010, not much has changed since then. Is possible to still post a comment? txs

  10. Tim Manni Says: December 28th, 2010 at 11:26 am

    Yes, still possible to comment. Thanks for your interest.

  11. bank of america loan modification victim Says: February 1st, 2011 at 12:21 am

    The government has swung and missed 8 times now.

    (1) How Now, (2) The Hope Line, (3) Hope for Homeowners, (4) FHA Secure – FHA Modernization Act, (5) Emergency Loan Modification Act of 2007,
    (5) Emergency Economic Stabilization Act of 2008,
    (6) Making Home Affordable, (7) Home Affordable Modification Program, (8) Home Affordable Modification Program 2.0 – Principle Reductions

    Why would anyone be surprised that there aren’t more principle reductions? Only when the pensions and insurance companies take on the banks and start winning in court will there be mass principle reductions.

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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