Principal Forgiveness: Not a Complicated Matter

I’m looking at loan modification papers for homeowners who recently came to ESOP for help on their delinquent mortgage.  I’m struggling to understand what I’m looking at because it seems to be a mistake.  It must be a mistake.  A home on the Westside of Cleveland, Ohio, with an outstanding mortgage balance of $174,400 has been reduced to $54,650. That’s $119,750 of principal reduction, 68 percent of the loan amount.

This is one of those SAM (Shared Appreciation Modification) workouts that Ocwen Financial has spent the last year touting inside and outside the Beltway. Ocwen is a subprime servicer with years of hard-knock experience dealing with the back end of the subprime mess and they're on to something our friends at FHFA seem not to understand, but more on that later.

Looking at the underlying numbers, the thinking behind the modification becomes clear.  The Marshalls bought their house in this neighborhood of tidy bungalows at the top of the market in 2006, with a subprime loan.  They hit a dry patch just as home values began to tank.

So they bought high, fell delinquent low, and what with penalties and fees, court costs, lawyers, and etc. the outstanding balance jumped to nearly $175,000. Under the Ocwen SAM, the Marshalls have to make three years of payments at the reduced interest rate on the reduced balance and each year 1/3rd of the $119,750 is deducted.  The upside for Ocwen’s investors is that they stand to get back 25 percent of any increase in value over $54,650 when the property is sold or refied.
This deal goes against what we have been told: that principal “forgiveness” won’t work, can’t work, and shouldn’t work, (because it’s bad for our morals).  Many of the arguments against adjusting the mortgage balance to match a collapsed home’s value are simply myths. Falsehoods, so often repeated, they become industry, and then, cultural memes. 

For example, how often have we been told that private label pooling and servicing agreements (PSAs) won’t permit servicers to make principal reductions, because modification options are so limited and locked down by contract language.  Not so, says Ocwen.  Read most PSAs carefully and the “prime directive” for the servicer is always the same: maximize cash flow and investor returns.  Not very complicated.  Actual fact: common sense and the duty to act in the client’s best interest is not usually prohibited by contract.

Here’s another legend:  Net present value calculations “are what they are”.  We are assured that NPV analysis is mathematically rigorous—-you can’t negotiate with numbers.  In fact, there are numerous input/variables for NPV calculations that are supposed to predict the value of future cash flows.  Not what the values are today, what they will be over the potential 30 to 40 year term of a modified mortgage.  (Care to venture a guess on what capital returns will be in 2053? Uh huh, sure.)  As a rule, two major NPV inputs have not been shared by servicers with borrowers.  The discount rate for future cash flows and the servicer’s estimated current value of their home.  There’s a lot of wiggle room here people, no one should be surprised that honest men can disagree about that-which-has-not- happened-yet. . . but might, in 40 years.

Truth is, net present value calculations are what we chose them to be, not “what they are.”

Rest assured Ocwen cleared this deal with their investor-clients.  Ocwen’s NPV inputs (whatever they were) simply persuaded investors that deep cuts now, will yield better returns later.  Investors will certainly lose money, but they will lose more money taking the home back. Not very complicated.

Then there is the Most Pious and Holy Meme of them all. Moral hazard will create “false” loan defaults by homeowners who see an opportunity to game the system.  Horrors!  What will we do?  What ever will we do?

Ever seen what happens to a credit score when a borrower falls 60 days behind on their mortgage?  Very ugly, and very costly to any American consumer. 

But let’s say a desperate homeowner will trade in their credit standing for a chance to bail or to get new and better price for their home.  (Yes, we know, it will happen.) But are we supposed to believe that a contrived delinquency cannot be discerned from reviewing the documentation required for loan workouts?  How many software products are peddled to loan originators, all promising to expose fraud or suspicious activity in a loan application?  And what is a loan workout but an application for a re-originated loan?

OK, but what about the moral hazard here, in the Marshall workout?  We asked the ESOP staffer who worked with the Marshalls.  “Well to tell the truth, it never came up.”  Not very complicated.

Deonna Kirkpatrick is communications director at ESOP, an Ohio-based ESOP, a nonprofit HUD-certified housing counseling agency.


  1. My mortgage is with Ocwen. I agree with the frustration with the outsourced call center staff. They really are quite useless. Now you have to remember, this is a Native American owned company and they are out to do nothing but make money. Because of their Native American status, they are not subject to a lot of the rules other companies would be.

    I too have tried a loan modification 3-4 times. Each time I’m denied because of some loan to income ratio not being exactly 30%. I’m sure if I could get the paperwork to show that, then there would be another excuse.

    Please keep in mind that the mortgage company doesn’t lose money if you default on your loan. That’s what the PMI is for. They get whatever difference from that insurance, plus they factor in all the interest they have already made off of you in the years before. They will always make out ahead. It’s not their job to care whether you have a house or not.

    With a loan modification off the table, the next option is to short sale. Beware here too, because OCWEN will stick you with a bill for the difference, plus you will have to pay 1099 rate taxes on that as well. Still, you will have no house & some lucky person will have had the opportunity to buy it for what it was really worth, while your still paying the difference. This is a really bad & twisted idea. Who thought this gem up?

    I saw online that there is this lawyer named steve beed who says that Ocwen has introduced a new program called the “SHARED APPRECIATION LOAN MODIFICATION”. Ocwen will receive 25% of Property future appreciation in return for reducing the principal balance to 95% of Fair Market Value, reduce the interest rate to 2% & forgive any deficiencies in 1/3 increments if the borrower stays current on their payments for the next 3 years. Sounds good, but I’m skeptical. I’m sure they’ve rolled this out for the PR Sound Bite alone, and in reality it will be next to impossible to qualify for… but I’m sure that will all reveal it’self shortly.

    In the meantime, I am considering bankruptcy. Think of it this way… continuing to pour interest into a mortgage, while not even touching the principal on a house that during it’s life time will never see that return investment just does not make sense. period. First secure a place to live that you can stay put for a few years while your credit is still somewhat good. Second, secure all your assets in trusts, etc… Third, file bankruptcy. What this does is wipes all of the loans you report in the filing. You will then be debt free and after a few years you can start over from scratch. What I have found from people (including security cleared government workers) is that a person with no debt is more favorable to someone who is loaded with debt and paying on time. You truly do get penalized big time for doing the right thing.

    After a few years you will be surprised to see that lenders will fall over themselves to have you start “reloading” your debt. seriously, this sounds crazy but it’s true. A friend of mine that did this is now (5 yrs later) buying a 1/2 million dollar house at the low 3% interest rates in Northern Virginia this very month. If I had just dumped my house as he recommended at the same time he did, I would be in the great shape he is in now. Live & learn.

    Of course, if you can qualify for HARP & be refinanced in the 3’s%… worst case is that you can rent the place out, pay any difference out of your own pocket & pray that in 30yrs property values on a really old house will go back up and you’ll break even.

    Another thing you may be able to do (if the house is only in 1 spouses name or you have a family member that can help you out) is to let it go into foreclosure, then have that other person buy it back at current market prices and the great interest rates we have now. You can be guaranteed that even if you get into a bidding war with someone, since you are emotionally involved (tho I advise you not to be), you will be willing to go higher than someone who is sheerly looking at the house as an investment vehicle and whatever you buy it for will be far, far less than you owe now. It’s only short sale that has rules relatives cant buy and that you can’t live in the house again. Just a thought….

    Emotions and financial decisions are never a good mix. It is only a house & you will find another one. It’s better to think ahead and do this intelligently than to be unprepared and put yourself into an even worse situation that you will not be able to lift yourself out of. Break the ties when you see there is no place to go but down, buckle in, wait for the ride to end and then rebuild. I wish I had, although I am extremely lucky to have not been in a situation yet that forced my hand. I can still prepare. Better late than never.

    oh, & btw… the only reason I bought the house at the price it was in the first place is because my fiance at the time was a real estate appraiser. He swore to me up and down that the house was worth the price and the values would only go up. I didn’t buy the house to make money or flip it… Now that my loan to value ratio is so extremely high, this affects my credit & it slaps me with PMI payments & other negative aspects. Additionally, what could have been a reasonable retirement safety net (thanks to welfare class eating my SS payments) or something in the event of a catastrophic illness like cancer that could provide a little emergency money… is now nothing but a black hole. Yeah, I could have sued him for his crappy appraisal skills, but so many other people sued him first that he lost his license and disappeared. Like I said – never let emotions and finance mix.

    What I learned after living w/my real estate appraiser fiance (who set up his business in the office located in the house) is that the appraisal process was a partnership with the real estate agents. They would call him and say “Ed, I have a house that is for sale at x$‘s. I need you to make that happen.” He would say “sure, I can finesse that for you.” As long as he found a way to make the #‘s work… he kept the work rolling in. Once the banks dried up the mortgages and everyone was underwater, then he got sued left right and center by poor elderly people who had lost their entire life’s savings. I felt bad for everyone. So… this isn’t just the fault of predatory lenders or greedy people buying more house than they could afford thinking they could flip it or people sucking the equity out of their homes to finance stuff (although that did exist too)…. I think a large part of this false inflation was mostly enabled by the appraiser/real estate agent relationship. I saw it with my own eyes & I fell for it too.

  2. Cindy, you have nailed it all the way. Everything you said is the truth about the way that the boom started to the way it crashed. It was one hell of a roller coaster ride. We sold our souls to the devil and they don’t say that pay backs are hell for nothing. I am in the same situation. My home is upside down but my pride is rightside up. I ‘m financial and emotional. I was able to get one of those modifications that only put a bandaide on a wound the size of the empire state building. It took 2 yrs of faxing and back and forthing with the WellsFargo crew to only get nothing knocked of the principle and 40 years tacked back on to the loan, when it was there fault that I became delinquent on my loan (they would’nt let me make a payment untill they stared me on my new road to hell trial payments) what a joke the whole thing was. In the mean time they were sending me scary forclosure mail. The whole experience is life threatening. Everyday that goes by is a reminder of what a mistake I made refinancing in the boom. (All the mail and flyers, calls and hype.) I ‘ve tried to refi but I can’t see adding closing cost to my already inflated property. You have some very good ideas about forclosure but I don’t have anyone that I can confide in to help me buy my house back. Yes I am attatched, I have lived here 26 yrs. Sometimes I want to give up but I am embarsed about the whole thing with the neighbors and my ex’s family lives down the street. I am waiting for a bus that may never come.(principal reduction)……A Lopez Tampa Florida


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