Government May Introduce Principal Write-Downs for Underwater Borrowers

Mortgage UnderwaterIn what can be described as an interesting move probably spurred on by Democrat lawmakers, Federal Housing Finance Agency director Melvin L. Watt said last week, that agency officials are thinking of implementing principal reductions for consumers who are “underwater” on their home loans.

A borrower is considered underwater if they owe more on their mortgage loan than the current market value of their homes – simply put, this means a borrower has negative equity on their property. And while Watt’s suggested reforms have the best intentions in mind, he noted in a press conference that the planned initiative will only have limited coverage.

According to Watt, the program may be “substantially narrower than the vision people have,” as writing down the principal of everyone who is considered underwater “would cost taxpayers billions.”

Watt did not expound further on his statements, but it can be guessed that the FHFA may limit write-downs to consumers who are considered “seriously underwater.” Reports suggest that the FHFA has been debating about the possibility for quite a few months, and seriously discussing possible restrictions or requirements. It goes without saying that defining the limitations of a potentially groundbreaking initiative will prove a Herculean task for the FHFA.

Data from CoreLogic recently indicated that there are approximately 5.1 million properties, or 10.3 percent of all homes with a mortgage, that were considered underwater as of the September ending quarter of 2014. However, home values have been gaining positive momentum in recent years, and while the obviously negative effect has been pricing would-be home buyers out of the market, the benefits for existing homeowners have been manifold. These include a continuing decline in the number of homeowners with negative equity; CoreLogic noted in its report that some 273,000 homes were back to positive equity in the September 2014 quarter.

In what should be a double-edged sword as it always is, home price appreciation has slowed noticeably over the past several months. In fact, CoreLogic’s stats showed that home values dropped 0.1 percent in December 2014 over the month prior. The good news is that means more consumers entering the housing market instead of worrying about double-digit home price increases, but the bad news is that this may mean certain homeowners, may they be underwater or near-underwater, may not be out of the woods after all.

Another thing the FHFA would need to consider is the potentially deleterious effect of such a reform to the mortgage lending business. Black Knight Financial Services recently released a report that says mortgage lenders may have to write down losses of close to $90 billion, should Congress allow across-the-board principal reductions for anyone and everyone who is underwater on their mortgage. Further, principal reductions on Fannie Mae or Freddie Mac-backed delinquent underwater mortgages could translate to about $18 billion in assistance.

All told, this has been another hot topic of debate between house Democrats and Republicans. The former sees principal write-downs as a tool to assist troubled borrowers and prevent them from losing their homes, while the latter fears that such a move may set a precedent. That is, the Obama administration may have to bail homeowners out in case prices actually take a hit like they did some years ago.