Principal Reductions May Not Save Enough Underwater Homeowners

Since the beginning of the mortgage meltdown millions of homeowners have defaulted on their loans and millions more remain underwater, owing more on their mortgages than their homes are worth. Government programs have encouraged lenders to modify home loans for struggling homeowners, yet only a small percentage have taken advantage of these programs.

Many lawmakers have been clamoring for a new tactic to be used by government-controlled mortgage financiers Fannie Mae and Freddie Mac, which guarantee about 90 percent of all new loans today. The Obama Administration as well as dozens of congressmen have asked Fannie and Freddie to grant principal forgiveness modifications, where a portion of the loan balance is written off, elimlinating borrowers’ negative equity and reducing their likelihood of defaulting. To date, the regulator of Fannie and Freddie has vetoed that option, worrying that it would cost the government too much money and would actually encourage homeowners to default in order to take advantage of the program.

new study from the Congressional Budget Office  (CBO) found that while principal reduction could help save some borrowers from foreclosure, the overall impact on the housing market would be minimal. Of the 10 million homeowners currently underwater on their loans, the CBO estimated that only 200,000 would be eligible for principal write-downs under the government’s Home Affordable Modification Program (HAMP.) The report found that fewer than 60,000 new modifications would in initiated and fewer than 100,000 defaults would be prevented. “The estimated aggregate financial benefit to households would be small,” the CBO wrote. “…[The] expected positive effects on the housing market nationally and on the economy as a whole would be small.”

This report, may make things complicated for North Carolina Representative Mel Watt, who was recently nominated by President Obama to be the next director of the Federal Housing Finance Agency, which oversees Fannie and Freddie. Watt was one of 44 House Democrats who commissioned the CBO study last fall, hoping it would prove the necessity of principal reductions.

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