After significantly revising the Home Affordable Refinance Program (HARP) and the FHA Streamline Refinance program, the federal government and mortgage lenders fall woefully short of helping the vast majority of 11 million homeowners who have underwater mortgages. An underwater mortgage simply means the borrower owes more on their home loan than the actual market value of the property.
On July 31, the acting director of the Federal Housing Finance Agency Edward DeMarco sent a letter to the U.S. Congress rejecting a proposal that would allow principal reduction for homeowners who have underwater mortgages. FHFA functions as the conservator and regulator of the insolvent government-sponsored enterprises (GSE) Fannie Mae and Freddie Mac.
The Principal Reduction Proposal
One of a number of proposals floating around to help troubled homeowners, this program would use government TARP funds to reduce borrowers’ outstanding home mortgage balances in line with the current market value of these homes. Mortgage lenders, such as Wells Fargo, Bank of America, Citibank, and JP Morgan Chase would ultimately receive a subsidy from the Treasury Department for every dollar of loan reduction completed under the program.
More importantly, these lenders can improve their bottom line by getting nonperforming assets off their books.
FHFA Rejection of Proposal
Many politicians and housing advocate have difficulty understanding why DeMarco has shown such strong opposition to mortgage reduction. Based on based on the Federal Housing Finance Agency’s in-house computations, mortgage forgiveness would save Fannie and Freddie approximately $3.6 billion compared to the current loan modifications programs supported by FHFA.
However, in the letter sent to Congress DeMarco states the FHFA’s evaluation determined that principal reduction would not help to “prevent foreclosure and save taxpayers money.” At most, a principal reduction program would only help about 248,000 homeowners.
In addition, mortgage lenders would have to spend resources developing a program, which impedes solving the underlying problem for many homeowners.
In DeMarco's opinion, a mortgage reduction program would encourage other homeowners to become delinquent in their mortgage payments – to create “hardship.” Hardship is one of the primary requirements for a homeowner to meet the basic eligibility requirement for getting a home loan modification.
DeMarco said that principal forgiveness only hurts the housing market and could harm the availability of credit. Rewriting the mortgage contract, according to DeMarco, would scare mortgage bond investors away from the market and may increase interest rates. The acting director further justifies his decision by saying that he has the primary responsibility to minimize taxpayer payers funds needed to bail out the GSEs.
So far, Fannie and Freddie have received $188 billion. According to DeMarco, mortgage forgiveness would inflate this amount because of the losses.
Geithner Does Not Agree
Treasury Secretary Timothy Geithner has refused to accept the FHFA’s analysis. He immediately sent DeMarco an eight-page letter asking the acting director to reconsider the agency’s controversial stance. Geithner admonishes DeMarco’s position as failing to present the “best decision for the country.”
Geithner also wrote, "You have the power to help more struggling homeowners and help heal the remaining damage from the housing crisis."
Preserving American Homeownership Act of 2012
This is not the final word on principal reduction for underwater homeowners. In June, lawmakers in the House of Representatives introduced a bipartisan bill that would require regulators such as the Federal Housing Finance Agency to formulate principal reduction programs for government back mortgages held by FHA, Fannie and Freddie.
The Preserving American Homeownership Act of 2012 would allow mortgage servicers to reduce loan balances to get homeowners down to a 115% loan to value ratio (LTV). Homeowners who keep their mortgage payments current for three years will receive an additional principal reduction to bring the loan down to a 95% LTV -- putting the homeowner into a positive equity position.
On the sale or mortgage refinance of the home, the borrower would be required to share up to 50% of any appreciation with the agency that insures the mortgage.