Foreclosure crisis phase 2: The negative equity dilemma

For almost a quarter century, Cynthia Johnson, a Boston homeowner, has paid the mortgage on her three-bedroom single-family house on time.

But in July, for the first time, she'll miss a payment.

"I'm on [the bank's] doorstep at this point, saying, 'The savings are gone. I can't pay you as promised,' " she said.

Unless something changes, Ms. Johnson (not her real name) is set to join the nearly 2.4 million Americans with prime loans seriously delinquent on their mortgages. They are the new face of the housing crisis. Unlike subprime borrowers, most of these homeowners did everything right. They bought houses they could afford and used standard mortgages. But falling home prices and a protracted recession have pushed them into a classic squeeze: They can't keep up their mortgage payments because someone in the household has lost his or her job. They can't sell because they owe more than the home is worth.

"In the next 12 months it's going to be tragic – most people are just starting to fall behind now," said Avi Liss, a lawyer helping homeowners avoid foreclosure in the Boston area. According to the Center for Responsible Lending, a nonprofit research and policy group, as many as 9 million homeowners could go into foreclosure between 2009 and 2012.

Is there a solution? Yes, but it's controversial. Congress would have to force banks to write off part of homeowners' troubled loans as a way to keep them in their homes.

There are plenty of reasons to avoid this course. Chief among them is the moral hazard. If banks write down one homeowner's loans because of hardship, what's to keep other homeowners from claiming hardship, too? And the losses don't accrue to some faceless bank; they add up for individual shareholders and pension funds that have money tied up in mortgage loans.

"In a way, reducing principal is like rewarding [homeowners] for backing out of an obligation," said Stan Longhofer, director of the Center for Real Estate at Wichita State University in Wichita, Kan.

But the current program isn't working either, critics say. And the debt write-down happens anyway, whether a homeowner goes through foreclosure or the house is relinquished in a short sale. So isn't it better, they ask, for the bank to take its losses early and keep the owner in his home?

Foreclosed on, but kept his home

Osazee Egharevba, a Nigerian immigrant who came to the Boston area in 2000 after his wife passed away, worked two jobs and saved enough to bring over his five children in 2006. That same year he purchased a two-family home. He could afford the $3,950 monthly payments by renting out the first floor.

Then Mr. Egharevba lost one job, and the extra $800 a week it brought in, and started missing payments. Deeply "underwater" on the $510,000 property (owing more than it was worth), he was foreclosed on this past winter, after five failed attempts at attaining a loan modification.

"My children were going to be on the street because there was no way, there was no home," he said.

But he stayed in the house. In April 2010, a nonprofit called Boston Community Capital was able to buy the home and sell it back to him for $296,000 – the home's current value. His monthly payment has fallen to a manageable $2,300. Egharevba doesn't get off scot-free. He is bound to share with BCC any profit he makes when he sells the property.

"There's no incentive for someone to do this to make money," says Patricia Hanratty, who runs the loan program at BCC. "This is for people who desperately want to save their homes."

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