It is disheartening to watch the enormous diversion of attention and energy focused on persuading the Federal Housing Finance Agency to give Fannie Mae and Freddie Mac the green light to use a proven tool – principal reduction – to reduce foreclosures while families across the nation drown in a sea of negative equity that holds back our economic recovery.
Research conducted by the UNC Center for Community Capital and others clearly shows the benefits of principal reduction in reducing foreclosures and stabilizing home values:
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Loan modifications with reduced payments and principal reduction have the lowest re-default rates. Center for Community Capital research shows that a combination of principal write down and rate reduction results in the highest mortgage repayment rates compared to other types of modifications. Federal Reserve Bank of New York researchers estimate that a combination of principal and interest-rate reductions would lower first-year re-default risk by 40 percentage points, nearly four times the impact from the interest rate-only strategy now commonly pursued.
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Principal reductions can also result in the best net-present-value outcome. Our research shows that principal reduction modifications, though they require the investor to give up a portion of possible future principal payments, can often result in a higher net present value than rate reduction modifications because they avert more costly foreclosures. Modifications made in hard-hit areas of the country that lowered a borrower's payment from 50 percent to 31 percent through a rate reduction posted success rates of only 40 percent, while those that used principal modifications had success rates of 58 percent. In such markets, when even greater payment reductions are needed, the research shows that using principal reduction in combination with rate reduction has the highest resulting net present value. The FHFA estimated that reducing the unpaid principal of all underwater borrowers in Fannie Mae and Freddie Mac's portfolio to 115 percent of their property's value would save more than $20 billion compared to not doing anything.
Still, less than 8 percent of loan modifications in the third quarter of 2011 reduced principal, according to the latest Mortgage Metrics Report released by the Office of Thrift Supervision and Office of the Comptroller of the Currency. In fact, more than 88 percent added (capitalized) past due amounts to the loan, increasing the remaining balance.
In the wake of the financial crisis, 3.4 million borrowers – nearly 8 percent of all mortgages – are currently 90 days or more late on their mortgage payments or are in foreclosure. Nationally, the glut of foreclosed properties exacerbate the fall in house values, leaving an estimated 10.7 million homeowners, roughly 22 percent of all mortgages, underwater.
It’s time to move on, give Fannie and Freddie authority to use this valuable tool to reduce foreclosures, enable families to remain in their homes, and get on with the business of finding a systematic way to restore homeownership for America’s families and our economy.
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