On the surface, it would seem that principal reduction to help get homeowners out underwater mortgages would make good financial sense for borrowers and banks. The idea being that it is much more profitable to mortgage lenders to modify mortgages by reducing mortgage principals and helping struggling homeowners to avoid a short sale or the foreclosure process.
However, that has not been the case and is something that has been especially puzzling considering the state of the U.S. housing market over the last three or four years.
When news broke in July 2011 that J.P. Morgan Chase had been quietly performing principal reductions on mortgages that were current and in good standing, the issue became even more confusing. After all, homeowners who owed more than their home market values received few principal reductions principal reductions to help right the ship.
Reluctant to Help Underwater Borrowers by Reducing Principals
Data released by the Office of the Comptroller of the Currency shows that for the quarter ending December 31, 2011, 9,867 borrowers received mortgage reductions. That figure equals 8.5% of total loan modifications, which took place during that period. On a year-to-year basis, it represents a 200% increase.
In addition, over 75% of loan modifications included interest rate reductions. Over 50% of the modifications extended the terms of the loans. In 2011, only 6% of the 35,200 homeowners, who received mortgage modifications, had their principal reduced.
Mortgage Settlement Forces More Principal Reduction
A provision contained in the $26 billion mortgage settlement reached in February requires J.P. Morgan Chase, Bank of America, Ally Financial, Wells Fargo and Citibank to complete about 1 million principal reductions as part of the agreement.
In early March, Bank of America announced that as many as 200,000 of their qualified borrowers will receive an average principal reduction of $100,000, which should bring their mortgages in line with the market value of their homes. Bank of America reached this side agreement in return for the government reducing financial penalties of $3.25 billion, by $850 million, assessed on the bank for foreclosure violations.
The other lenders will reduce the principal of eligible borrower by an average amount of $20,000, which critics say will do little to help those borrowers get their heads “above water.” In total, homeowners will receive about $17 billion in principal reductions.
The mortgage settlement only applies to private mortgages. The Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, has received increasing pressure to allow principal reductions to help borrowers who have mortgages insured by the two Governments –Sponsored Enterprises. Many housing economists believe principal reduction represents the only viable alternative to help the vast majority of the more than 11 million American who have underwater mortgages.