Administration: Principal reduction keeps foreclosures in check

another foreclosure, more to come

The regulator for Fannie and Freddie won't let the agencies participate in principal reduction to prevent underwater mortgages. Image: CC Asurroca/Flickr

A battle over principal reduction as a way to keep underwater mortgages and foreclosures from increasing is being waged in Washington. The Obama administration is trying to convince Fannie Mae and Freddie Mac to join a program that reduces the balance of underwater mortgage loans. Experts say the program won’t work unless Fannie and Freddie are on board, but the regulator of those agencies opposes their involvement.

Stemming a rising tide of foreclosures

Principal reduction — reducing the amount owed on a mortgage loan — is viewed as a benefit to both borrowers and lenders. It is expected to serve as an incentive for underwater borrowers to stay in their homes and benefit lenders  more financially than they would through a foreclosure. Nearly 25 percent of U.S. mortgages are underwater. As U.S. home values continue to fall, that number is expected to increase. Government officials have estimated that up to 1.5 million underwater mortgages could be saved from default by principal reduction, which was recently added to the underperforming Home Affordable Modification Program.

Principal reduction program needs Fannie and Freddie

To jump start a sputtering HAMP program, in October the administration started offering banks additional subsidies in return for principal reduction on underwater mortgages. To qualify, borrowers have to be current on mortgage payments and owe at least 15 percent more on their mortgages than their homes are worth. The administration and bankers agree that without Fannie Mae and Freddie Mac going along, the program is unlikely to work. Fannie and Freddie own about half of all U.S. mortgages. So far banks have been reluctant to support principal reduction. The consensus is that if Fannie and Freddie join in, the biggest banks in the U.S. will be pressured to do the same.

Why Fannie and Freddie won’t play

Fannie Mae and Freddie Mac have stayed on the sidelines because the regulator of the agencies, the Federal Housing Finance Agency, opposes their participation. When the government had to take over the mortgage giants in 2008, FHFA was charged with curbing losses at Fannie and Freddie. In the past two years the agencies have cost U.S. taxpayers about $134 billion, and those losses are expected to increase. The Obama administration is pressuring the FHFA to let Fannie and Freddie in. They say short term principal reduction will mitigate more severe long-term losses. But the FHFA says as long as underwater borrowers keep making their payments as is, Fannie and Freddie will keep taking their money.


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