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November 18th, 2010

If principal reductions are working, why aren’t more being done?

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“If you want successful modifications, you have to do principal reductions.”
-Laurie Goodman, Senior Managing Director of ASG

How many times have we heard that before? To put it simply, “a lot.”

Principal reductions are a very gray area in this era of loan modifications, especially when it comes to Fannie Mae and Freddi Mac. While neither the public or private market has yet to claim much success in terms of loan modifications, statistics are starting to sway in the favor of private-market modifications, rather than HAMP modifications.

According to an article by Brian Collins in the latest issue of National Mortgage News, Goodman, like many, feel that because most successful modifications have principal reductions tied to them is “very convincing” of just how important they are to long-term homeowner success.

The “Principal Reduction Alternative Option”

Knowing this, the Making Home Affordable program implemented the Treasury’s new “Principal Reduction Alternative Option” beginning on October 1. Unfortunately for all the borrowers out there salivating at the mere thought that their principal balance could be reduced, the Treasury’s initiative is only what it says it is: an option for servicers to consider.

So even with a new wrinkle to the MHA program introduced by the Treasury, why aren’t more principal reductions being done?

Why aren’t more principal reductions being done?

Well, for private lenders, a principal reduction is a question of, “Is an immediate loss better than a potential loss later? Which produces the least loss?” As the stats show, some private lenders have moved forward with implementing principal reductions because they’ve decided it was best for certain borrowers, and more importantly, their books.

It’s complicated

What complicates the principal reduction issue for Fannie and Freddie, who have opted out of the Principal Reduction Alternative Option for the time being, is that they’re now operating with taxpayer dollars. Their lack of private funds to use means they must answer to taxpayers. It would mean that Fannie and Freddie would essentially be picking winners and losers — those who get a principal reduction and those who do not.

Doing the right thing

We already hear complaints from readers who say there’s no assistance being offered to borrowers who are still current on their loans, but can’t even refinance. Imagine the backlash if all of a sudden Fannie and Freddie were using taxpayer dollars to eliminate a portion of what certain (already-delinquent) borrowers had to pay back?

We’ve already begun to see the incentive for doing the right thing go out the window with strategic defaults. I imagine that there wouldn’t be too many borrowers left who would continue to pay their mortgage on time if they knew a principal reduction was waiting for them as soon as they missed a few payments.

HAMP: One size fits all

Here’s one more reason private mods have been more successful: private servicers have more “creative” freedom. HAMP is a rather strict and rigid process where a servicer must follow certain steps and procedures to get a borrower’s loan down to a certain level of “affordability.”

The reality is, what’s tripping one borrower up may not be hurting another borrower. Look at it this way: While one borrower (seeking a private mod) may need a forbearance to get back on track, another borrower may need an interest-rate reduction while another may need an outright principal reduction.

Will Fannie and Freddie be hoping on the principal reduction bandwagon? Don’t count on it. I’m pretty sure Fannie and Freddie won’t begin reducing borrowers’ principal under HAMP, at least not as long as they’re still under conservatorship.

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3 Responses to “If principal reductions are working, why aren’t more being done?”

  1. Tweets that mention If principal reductions are working, why aren’t more being done? | HSH Financial News Blog -- Topsy.com Says: November 18th, 2010 at 8:03 pm

    [...] This post was mentioned on Twitter by HSH Associates, Mortgage News. Mortgage News said: [HSH] If principal reductions are working, why aren’t more being done? http://ow.ly/1a377k [...]

  2. curmudgeonman Says: November 23rd, 2010 at 12:22 pm

    “We’ve already begun to see the incentive for doing the right thing go out the window with strategic defaults. I imagine that there wouldn’t be too many borrowers left who would continue to pay their mortgage on time if they knew a principal reduction was waiting for them as soon as they missed a few payments”

    May I add that we have already seen the incentive for lending institutions and creators of MBSs to “do the right thing” go out the window with intentional dismantling of underwriting standards, suborning appraisers, rating agencies, regulators, destruction of chains of title, etc. I imagine there would not be too many honest banking officials left that would be satisfied with compensation based on traditional underwriting standards and legitimate appraisals of the quality of their loans once they figure out that inflated prices, inflated fees, with the risks dumped on unsuspecting investors and low risk of personal prosecution are realized. AND when they get in trouble their bonuses are guaranteed by the US taxpayer. Talk about your moral hazard! Borrowers could take lessons from the morally and literally bankrupt institutions these officials run. Let’s start marking to market for example and see how many bonuses get paid!

  3. Tim Manni Says: November 23rd, 2010 at 1:17 pm

    curmudgeonman,

    Thanks for your comment. More and more borrowers are tired of doing the right the thing when they continue to see those financially rescued not doing the right thing.

    Will taxpayers ever be able to stand up to the big banks?

    Hope to hear from you again soon,
    Tim

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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

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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