THE BASIS POINT

Mortgage Principal Reductions: Yes or No

Edward Demarco, head of the FHFA which oversees Fannie and Freddie, has been steadfastly against principal reductions being pushed by some politicians.

He recently noted that Fannie and Freddie own or guarantee 60% of the outstanding mortgages in the country but account for only 29% of seriously delinquent loans.

But over half of the modifications done through the Home Affordable Modification Program (HAMP) are on Fannie and Freddie loans.

Between HAMP and Fannie/Freddie’s own proprietary programs there have been more than 1.1 million modifications of Fannie/Freddie loans completed since the fourth quarter of 2008.

The agencies have taken the approach that modifications are better: to adjust the payment to an affordable level.

This lower payment, rather than a change in LTV from a principal reduction, has proved to be the key to a successful modification, and Fannie/Freddie achieve this through principal forbearance (charging a zero rate of interest on the forbearance amount and deferring its repayment).

This makes the monthly mortgage payment affordable, keeps the borrower in the home, and if the borrower is successful in this modified loan preserves for taxpayers an ultimate recovery on the debt.

In other words, the method used by Fannie/Freddie produces the same lower payment as a modification based on principal forgiveness, and if the borrower ends up defaulting on a forbearance, the loss to the taxpayer will be the same.

If the borrower is successful, however, the taxpayer retains the opportunity to benefit from the upside, “a reasonable deal given the support the taxpayer has provided to assist the family in keeping their home.”

DeMarco said this approach also recognizes that three out of four deeply underwater borrowers on Fannie/Freddie books are current on their loans. Their continued willingness to meet their obligations should be recognized and encouraged, not dampened with incentives to discontinue payment.

Then there are a host of other questions:

Will appraisals be required for principal reductions?

Why would a borrower refinance when there is the possibility that Fannie & Freddie will be told to reduce what you owe in one big stroke?

The implications are HUGE – what about all those poor FHA, VA, portfolio, jumbo, USDA, bond, rural housing, etc., borrowers?

Read more below…
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Reference:
Final Word From FHFA On Principal Reductions Coming In April (Reuters)