As more than 5 million Americans fall behind on mortgages, banks signal a new willingness to reduce the principal.
Some homeowners who are having trouble paying the mortgage may be getting genuine relief.
An increasing number of lenders are now willing to do what they have long been reluctant to do: reduce the principal of a troubled loan. That shift is in part a recognition that home values have dropped sharply, foreclosure rates are soaring, and the political climate in Washington has shifted.
Advocates for borrowers hope the new modifications work better than prior efforts, which were not that generous: A government report found homeowners who modified their loans defaulted a second time at a very high rate last year.
The change in some lenders’ willingness to forgive and forget won’t come a moment too soon: Some 5 million to 6 million homeowners are now either behind on their mortgages or facing foreclosure. And over the next 12 months, the interest rates on $1 trillion in adjustable rate mortgages will be resetting at a time when the nation’s unemployment rate is climbing – factors expected to put more homeowners under financial stress.
The economy is now at a point where people can expect to see more restructuring of mortgages, says Alan White, a professor at the Valparaiso School of Law in Indiana. “It’s not too late to change course, and there are some indications we might be changing course.”
For example, last week, Federal Reserve Chairman Ben Bernanke wrote Rep. Barney Frank, chair of the House Financial Services Committee, to inform him the nation’s central bank has a new policy to avoid preventable foreclosures on the $47 billion in residential mortgages taken over from troubled financial institutions.
“This is important because the government will control more and more of these assets,” says Mr. White.
On Jan. 26, Wells Fargo, which purchased Wachovia Bank, said it would try to work with 478,000 Wachovia customers to avoid preventable foreclosures. In addition to term extensions and interest-rate reductions, “In geographies with substantial property value declines, we will even use permanent principal reductions,” said Mike Heid, copresident of Wells Fargo Home Mortgage in a statement last week.
And recently, Citibank broke with other lenders in supporting legislation that will allow a bankruptcy judge to modify the principal on a mortgage. The legislation was voted out of a House committee last week.
The banks are also under increasing political pressure. Treasury Secretary Tim Geithner will soon announce a new strategy for reviving the financial system, President Obama said in his radio address Saturday. The administration has already said it will devote between $50 billion and $100 billion of the remaining bank bailout funds towards preventing foreclosures.
The new willingness by some lenders comes at a time when new data indicate that, unless a bank is more generous with negotiations, a sizable number of borrowers will default again. In December, the Office of the Comptroller of the Currency issued a report that found, in the first quarter of last year, 25 percent of modified loans redefaulted in one month and 58 percent redefaulted in eight months.
At a national forum for housing in December, John Dugan, the Comptroller of the Currency, asked why the number of re-defaults was so high. “Is it because the modifications did not reduce monthly payments enough to be truly affordable to the borrowers? Is it because consumers replaced lower mortgage payments with increased credit-card debt? Is it because the mortgages were so badly underwritten that the borrowers simply could not afford them, even with reduced monthly payments? Or is it a combination of these and other factors?”
Groups that advocate for troubled homeowners say the answer is not that complex.
“Right now we have loan modifications that don’t reduce the monthly payment,” says Jim Carr, Washington-based chief operating officer of National Community Reinvestment Coalition, a group of 600 local development organizations. “It’s hard to believe how anyone can conceive of that as making the loan more affordable.”
In the past, the mortgage industry has supported efforts such as the Hope Now Alliance, which estimates it prevented 2.2 million foreclosures last year. A lot of its efforts go toward voluntary interest-rate moratoriums by lenders or efforts to modify mortgages without affecting the principal amount due.
However, future revisions may also need to factor in how much homes have dropped in value. “Someone who may have been in a $100,000 loan at the peak of the market now [is] looking at a house valued at $75,000, which means the mortgage company has to write off 25 percent of the loan,” says Tony Brancatelli, a Cleveland city councilman and expert on troubled housing. “The mortgage companies are still not writing down the loans enough to meet the market losses.”
But mortgage servicing companies also are aware there is a risk in writing down the principal in a mortgage. “You can destabilize market values,” says Ed Delgado, a senior vice president at Wells Fargo in Fort Mill, S.C. “A homeowner who has been granted a principal reduction could potentially be more willing to discount a sale price, versus a homeowner who did not enjoy a similar reduction in obligation.”
One mortgage servicing company that has been lowering the principal amount owed is Ocwen Financial Co. Nineteen percent of all the modifications in the company’s portfolio included some component of principal reduction, says Paul Koches, executive vice president and general counsel for the company based in West Palm Beach, Fla., in an interview. “The average loan balance for these loans, pre-mod, was $157,000, and the average principal reduction was $33,000,” he says in an e-mail.
“Principal reduction is a last resort,” he adds, but is preferable to foreclosure, which results in less money for the investors who made the original loan. Ocwen’s redefault rate is half the national average.
Advocates for borrowers say it’s critical that lenders give some leeway to troubled borrowers.
“A lot of time, the interest-rate cuts have just not been that great,” says Moe Bedard, founder of Loan Safe Solutions. “People need a little breathing room.” Mr. Bedard says hard-pressed borrowers are taking loan modifications but still redefaulting. “Some are saying, ‘I’ll take the modification, but in six months I’m outta here.’ ”
That is one reason some people counsel the need for a holistic approach. “You could be modifying the loan, but there could be other debt and issues in the household,” says Marietta Rodriguez, who runs the homeownership program at NeighborWorks in Washington, D.C. “You need to look at ... changes in income or other debt loads.”