By Lorraine Woellert
When Javier Gonzalez saw that the value of his Hawthorne, California, townhouse had fallen below what he owed on his mortgage, he decided he had three choices. He could make payments he might never recover, walk away from the loan, or get his lender to reduce his principal.
When Gonzalez, 39, a communications consultant who bought the home for $450,000 in 2007, had no luck with his bank, he decided it was a bad investment. He stopped making payments and moved out in October 2009.
“The bank laughed when I said I wanted a principal reduction,” Gonzalez said.
Three years after the collapse of the housing bubble, one of the questions weighing on the real estate market is whether and when to write down the value of outstanding mortgages. Millions of houses, including almost a third of California’s mortgaged homes, are worth less than what was borrowed on them, according to CoreLogic, a real estate data company in Santa Ana, California.
While several states and the Federal Housing Administration have developed programs to encourage write-downs, the number of principal reductions remains small and suggests the problem goes beyond the reticence of banks.
Widespread principal reduction remains a key goal for state attorneys general and the Justice Department, which are in settlement talks with servicers over botched foreclosures. Prosecutors want banks including Bank of America Corp. (BAC), JPMorgan Chase & Co. (JPM), and Wells Fargo & Co. (WFC) to spend billions writing down principal. The banks and mortgage servicers have refused.
On June 21, Georgia Attorney General Sam Olens said states might get to choose how they spend their share of any foreclosure settlement with banks, including on write-downs.
Last year, California, Arizona and Nevada developed a single set of rules and offered up to $50,000 in matching funds per loan to make write-downs work financially for loan servicers and investors.
“It’s better for communities to encourage people to stay in their homes,” said Diane Richardson, program director for Keep Your Home California, the state program. “It’s better for their kids to keep them in the same schools. We wanted to try to find a way to encourage them to stay put.”
Despite the states’ offer, only one national loan servicer, Bank of America, is cooperating and borrowers are proving reluctant. Fewer than 300 Californians have applied. Nevada has completed just 114 principal reductions and Arizona just three, according to state officials.
Fannie and Freddie
Banks that service home loans say one reason for the underwhelming response is that government-sponsored mortgage investors Fannie Mae and Freddie Mac, who own most of their mortgages, forbid principal write-downs, as do many private mortgage investors. About 70 percent of all mortgages are held in securities, not on bank portfolios, complicating efforts to alter the terms.
Moreover, reducing loan balances could work at cross- purposes to other government goals, including conserving Fannie Mae and Freddie Mac assets, which are 80 percent owned by the government and managed by the Federal Housing Finance Agency. FHFA bans write-downs because lowering principal would lower the value of the two companies’ assets at a time when they continue to rely on taxpayer aid to operate, FHFA Acting Director Edward J. DeMarco said in a March letter to lawmakers.
At Wells Fargo, the nation’s largest mortgage originator, Fannie Mae and Freddie Mac own two-thirds of the loans the company services.
“Those are off limits. We have to confine our efforts to other areas,” Wells spokesman Tom Goyda said. The bank considers foreclosure “a last resort,” and as such has reduced principal on some loans it owns, including pay-option adjustable-rate mortgages, or pick-a-payment loans.
“Because of the product structure and the geographic concentration of the pick-a-payment loans we have more aggressively used principal reduction for those loans,” Goyda said.
Bank of America Chief Executive Officer Brian Moynihan and other executives also cite the “moral dilemma” of debt forgiveness. Should underwater homeowners behind on their mortgage payments get aid while their responsible neighbors who suffered the same drop in home values get nothing?
Moreover, if the primary goal is to secure more affordable monthly payments for individual borrowers, that can be accomplished by deferring debt, extending loan terms, or reducing interest rates, banks say.
Not Broad Basis
“We do not see principal reduction as a solution that should or can be used on a broad basis,” Bank of America spokesman Rick Simon said.
States aren’t the only ones struggling to get banks on board. A year-old Federal Housing Administration effort that pays lenders to write down second liens and refinance underwater debt has drawn only 207 takers so far.
In all, banks wrote down principal on fewer than 5,000 loans in the fourth quarter of 2010, according to the Office of the Comptroller of the Currency.
About 23 percent of U.S. homes have negative equity totaling about $750 billion, as reported by CoreLogic. In contrast, the biggest banks combined hold a total of $717 billion in Tier 1 capital, according to Bloomberg data.
As states continue to negotiate with banks, they also are coping with borrowers who seem fatigued by a flood of aid programs that so far haven’t helped much.
“I thought when we announced the program that everybody who had a mortgage would be calling to see if they qualify,” California’s Richardson said. “They’re not. I’m a little surprised at the work we have to do to get the phone to ring.”
Gonzalez said he would have leapt at the opportunity. “I would have stayed in the house for $40,000 or $50,000,” he said. “I needed just a few hundred dollars more of discretionary income a month.”
State write-down programs are limited to low- and middle- income homeowners who can make their payments and who haven’t taken cash-out loans against their homes. Banks are granted up to $50,000 in matching funds, meaning eligible borrowers could shrink their mortgages by as much as $100,000.
The states have hired marketing consultants to get borrowers’ attention. California this month began airing public service announcements on radio and television.
Data Not ‘Profound’
“It’s hard to justify principal reduction,” DeWeese said. “The data so far available is not profound enough on the ground to convince the banks.”
Moreover, the math still doesn’t add up for lenders. For houses mortgaged at twice or more of their value, the cost of principal reduction “is gigantic relative to the cost of a foreclosure,” he said.
Still, consumer advocates say such aid is long overdue. Homeowners innocently swept into the run-up in home prices are now bearing the financial and psychological burden of a mortgage they might never be able to repay.
“There was a lot of money put into rescuing the banks and not nearly the resources put into rescuing regular folks,” said Bruce Mirken of the Greenlining Institute, an economic policy group in Berkeley, California. “A fair number of these loans were written based on fantasy values. It’s better for everybody concerned to have a mortgage market and a housing market that has some connection to reality.”