33,000 Lucky Borrowers May Get Their Mortgage Balances Reduced
Well, it took a lot longer than anticipated, but Fannie Mae and Freddie Mac have finally unveiled the so-called “Principal Reduction Modification” program for underwater homeowners still struggling to make monthly mortgage payments.
Perhaps most importantly, we know the program will be significantly smaller in scale than related relief initiatives such as HARP and HAMP. Apparently only 33,000 homeowners will be eligible for principal forgiveness under the new program.
For those who are, it will be welcome relief that seemed as if it would never come. I’m surprised myself, I assumed it was never going to happen.
The plan was recently approved by the Federal Housing Finance Agency, which oversees Fannie and Freddie, and is meant to be the “final crisis-era modification program” released to help borrowers with negative equity.
It is essentially an add-on to the Streamlined Modification program already in existence.
Nearly Five Million Homeowners Were Underwater in 2011
By the end of 2011, some 4.6 million homeowners with a mortgage backed by Fannie Mae and Freddie Mac were underwater, according to a speech given by FHFA director Mel Watt at a public policy luncheon in D.C. yesterday.
Most of these borrowers were able to keep up with monthly mortgage payments, but over 580,000 were at least 90 days in arrears, representing about half of all late paying Enterprise (Fannie/Freddie) borrowers at the time.
Fast forward to today and the number of underwater homeowners with an Enterprise loan has plummeted by more than 80% since peaking in 2011. And most of these remaining underwater borrowers happen to be current on their mortgages, with only around nine percent seriously delinquent.
This dwindling number has complicated the launch of a principal reduction plan, per Watt, because a smaller number of candidates might not outweigh the costs “and significant operational complexity” for the FHFA and loan servicers to implement such a program.
But apparently there are still enough at-risk borrowers to go ahead with it, even if it’s only some 33,000 homeowners.
Must Be a Win-Win for Borrowers and Fannie and Freddie
Ultimately, Principal Reduction Modification program is meant to be a “win-win” for both borrowers and Fannie/Freddie.
So if it doesn’t benefit both parties a principal reduction won’t be offered. In order to determine this, lenders will need to do the math to see which option, principal reduction or foreclosure, results in a smaller loss.
If it turns out foreclosure is still the best option in terms of financial loss for the companies involved, they will proceed with foreclosure. But if a principal reduction can reduce losses, it will be offered.
The new program will also be limited to loans with a principal balance of $250,000 or less, and borrowers must be owner-occupants that are at least 90 days behind on the mortgage as of March 1, 2016.
So it appears as if they’re targeting smaller loans as opposed to those in more affluent areas that have already bounced back from the mortgage crisis. And only delinquent borrowers.
Principal Reduction Remains Extremely Controversial
The reason this nuclear option wasn’t offered earlier is due to the controversy involved. Ultimately, the FHFA didn’t want to set a precedent in which borrowers could expect to be bailed out if things didn’t pan out as expected.
If they had offered principal reductions back when home prices bottomed, they may have overcompensated homeowners who have since seen their property values rise back to prior levels or even new highs.
It likely would have been too costly back then, while also sending the wrong message to homeowners. And, let’s not forget that taxpayers are on the hook here, seeing that Fannie and Freddie are in government conservatorship, so the decision to forgive has to be an extremely thoughtful one.
Because this program is being launched so late, its impact will likely be muted, but maybe that’s the point.
If your loan is owned by Fannie or Freddie and you’re underwater and behind on your mortgage, keep an eye out for details that might offer you new hope.
Fannie/Freddie Principal Reduction Modification Program
- Limited to around 33,000 homeowners
- First mortgage must be owned by Fannie Mae or Freddie Mac
- Must be underwater on your mortgage
- Must be delinquent on your mortgage (90+ days as of March 1, 2016)
- Maximum unpaid principal balance of $250,000
- Mark-to-market LTV must exceed 115 percent
- Principal reduction will be offered only if foreclosure proves more costly
- Loans already approved for a short sale/deed-in-lieu not eligible
How the Principal Reduction Modification Works
You should receive a Streamlined Modification solicitation letter no later than July 15th, 2016 if you are potentially eligible (though the FHFA says loan servicers may still solicit eligible borrowers until December 31st, 2016).
Assuming you qualify, which isn’t a guarantee just because they reach out, a trial modification will begin if you wish to take part. You have to make three timely payments in order to get the principal amount forgiven.
The modification will also reduce your mortgage payment by including an interest rate reduction and loan term extension to 40 years. You will receive principal forbearance that will eventually be converted to forgiveness if you meet the terms of the modification program.
It’s important to note that you must already be 90 days late as of March 1st, 2016. You can’t just default on your mortgage now to gain eligibility.
If you’re attempting to avoid foreclosure immediately, before the Principal Reduction Modification is rolled out, you still have the option of applying for a Streamlined Modification now to halt proceedings and obtain payment relief.
Then once the Principal Reduction Modification program is fully implemented and it is determined you’re eligible for principal relief, it will be granted.
For the record, if you’re not interested in a principal reduction, but still want your payment modified, you have the choice to opt-out once forgiveness is offered.
There may be tax consequences to accepting principal forgiveness and the FHFA says themselves that borrowers “may be able to benefit from the exclusion of forgiven mortgage debt from taxable income.”
It’s unclear if they’re still working on this exemption with the IRS so tread carefully. In the meantime, check your mailbox or reach out to your servicer for details if you want to be proactive.