HUD pushes for principal reduction up to 30%

(I didn’t want this story to get lost in the midst of all the headlines the past few days.)

From the National Mortgage News headlines:

“The Department of Housing and Urban Development is seeking expanded loss mitigation authority allowing the principal amount of an FHA-insured mortgage to be reduced by up to 30% to help homeowners avoid defaults.”

FHA has some poorly performing loans. Many of these loans that are delinquent have a history of defaulting shortly after origination whether it be a refinance or modification.

If the principal reduction takes place what will be some of the “strings” attached, if any? Two questions that immediately come to mind are:

  • Will the borrower have to pay back any principal in a future date or after a sale ?
  • Will the IRS treat the reduction as income?

The program of principal reduction may help keep people in their homes, at least in the short term, and reduce foreclosures. However, I’m opposed to principal reduction, in part, because in my experience a substantial number of people were irresponsible in serial refinancing and overall poor financial planning. On the other hand, principal reduction may save FHA from paying out to lenders for losses that may exceed the amount of the principal reduced to keep borrowers in their home (in foreclosure, HUD may end up taking a larger loss).

Responsible homeowners may be torn about hearing that their neighbor received a principal reduction. How would you react when a neighbor walks by your house while you are working in the yard on a Saturday morning and strikes up an innocent conversation with you about their good fortune of having their FHA loan principal reduced up to 30%? Sure it may have saved a potential foreclosure, but to the core, it has to be frustrating for the homeowner that is working their tail off to make a living and pay their mortgage as scheduled. It may be even more frustrating for a recently unemployed homeowner that is using ‘rainy-day’ savings or selling investments (what is left of it) to pay their mortgage and living expenses.

In other news: In real estate, I have always been an advocate of just watching what people do vs. listening to what they say. Jillayne Schlicke has a perfect example of this in a Forum commentary today (click her links).

S-Crow

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About S-Crow

"S-Crow" (Tim Kane) is co-owner (with spouse Lynlee, LPO-Designated escrow Officer) of Legacy Escrow Service, Inc., an authentic independent escrow firm closing residential purchase/sale and refinance transactions.

26 comments:

  1. 1
    DrShort says:

    I sure hope they have to repay the “reduction” when the house sells.

    Why not amortize the loan at the new reduced principle amount and have a ballon for the remaining at the end of the loan? Is the goal affordable payments or to reverse someone’s bad investment?

  2. 2
    redmondjp says:

    I’m hoping that this is an April Fools’ post, but somehow I doubt it!

    Even with a 30% reduction, how many eventual foreclosures or short sales will this actually prevent? Say that somebody’s mortage goes from $3K/mo to $2.5K/mo (#s out of thin air), and then they lose their job. Does the 30% reduction even help? If the homeowner has el-zippo equity anyways, won’t they still be very likely to just walk away if they can’t afford the payments?

    I’m against this idea as well. They SIGNED on the dotted line. I even sat in the room at escrow for almost two hours and read pages and pages of small print (do you know that you’re not even supposed to store any hazardous or flammable substances in your house? Get that can of gas for the lawn mower out of the garage NOW!!!) before I signed the papers on my home.

    Just because people don’t read all that stuff doesn’t excuse them for the responsibilities that they are signing on for. That’s my $.02.

    Loved the Gmail signin page today, BTW! Somebody should save a screenshot before midnight.

  3. 3
    Ray Pepper says:

    S-Crow , although I have no evidence of it yet I understand this Mtg Cramdown has already been happening in Calif and Nevada with a variety of banks. I say it again…People will NOT stay in their upside down Mtg’s for any great length of time. We live in a mobile society and its not a question of IF———–only WHEN. People will keep walking and foreclosures WILL continue until MTG Cramdown occurs widespread. Right or wrong this is the only viable option that I have heard to reduce the foreclosures.

    There will be restrictions put in place that if you sell within the 1st 5-10 years 1/2 of the potential profits will be forfeited to the bank or some variation of this. Reducing interest rates to even 0% is a bandaid on a gaping wound. At the 1st sign of a better job, divorce, better deal, illness, anything —-the home will end up as a short sale/foreclosure anyway. People will NOT bring vast sums of cash to get the home off their books. They don’t have it and I reiterate its just a matter of time for these homeowners.

    Enough with Mtg drops to 0-4%…………………………….It will not work.

  4. 4
    Jonness says:

    If they can’t afford the house, let them rent a place they can afford. Why keep an unemployed strawberry picker in a house he can’t afford in exchange for forcing someone with savings and a good job to continue renting another 5 years because he’s unable to afford to buy? On top of that, why should the guy with the job and savings pay for the strawberry picker’s home? This is out and out crazy!

    The politicians are robbing us blind, and all we can do is continue to save in order to afford to pay for the banks’ executive bonuses.

  5. 5
    Scotsman says:

    What a waste of time and money. People don’t seem to be able to deal with the fact that asset values have fallen, and there is a loss to take. There is nothing anyone can do- principle reductions, lower interest rates, cramdowns, etc. that is going to restore that lost value and re-establish the glorious bubble economics of the past. Current law establishes who should have to shoulder the loss. Why does everybody want to play musical chairs now? Allowing these games to be played is going to bankrupt the country as pandering politicians and whiny bankers try to push ever more onto the taxpayer. There are no adults in the room. We’re hosed.

  6. 6
    Nick says:

    I have a better idea: why doesn’t every single person who works/worked for the HUD who gave and/or is still giving out these ridiculous obscene garbage loans be made personally liable for every penny of missed payments above the national average default rate % for prime loans. It’s appalling that these people are allowed to still be giving away taxpayer money to deadbeats, much less the billions which have already been squandered. Make em all personally liable, from the clerks who signed the checks all the way up to the morons in Congress who expanded the pool of money they were able to flush down the toilet into the cesspool of sub-subprime feces now being dumped onto the heads of every American who tried to live within their actual means.

    It’s not like everybody involved didn’t know they were giving out guaranteed default loans. It’s not like everyone wasn’t at least complacent in the negligence and downright fraud, if not actively facilitating it. It out to be a crime against the country to waste so much of our money, so obviously, maliciously, and with full understanding of the eventual outcome, and the perpetrators/conspirators ought to be made to pay (IMHO).

  7. 7
    cheapseats says:

    I think that forced write downs on principle would have a compounding negative effect for sellers not buyers, they should make it count as a new sale for comps though.

    But it does suck as a taxpayer.

  8. 8
    EconE says:

    Well…if they,re gonna knock down principal by 30%, then perhaps Congress should get off it’s collective fat a$$ and issue a mandate for the NAR to lower MLS asking prices by the same amount so that prices can return closer to the fundamentals.

    But of course, they’d rather keep “values” artificially inflated. Not so much the NAR as they only get a measly one time percentage. The government would love for you to “believe” that your home is worth more than the true market value…and they’d LOVE to tax you accordingly….

    …for the rest of your life.

  9. 9
    Charles Mawby says:

    BEWARE – MORAL HAZARD

    Already people who can afford houses are intentionally not paying. They want free money too. So Congress PRINTS more money… essentially taxing all of us.

    Hello hyperinflation… an illegal tax on everyone owning dollars. Bring back the gold standard.

  10. 10
    Mark says:

    RE: Ray Pepper @ 3

    I agree Ray. I have a neighbor that is under water anywhere from $150k – $250k. He is a real estate agent and moved out a couple of months ago. His home is currently rented. I figure he’s around $1500 per month short of making his nut. He’s waiting for the market to come back and sell. He has tried to sell his home twice in the past 18 months without any success. I’m expecting him to walk at some point. The only question is when.

    Oh, he owes around $550K and the place is worth maybe $300k – $400k.

  11. 11
    Kary L. Krismer says:

    I’d assume there is a repayment of the reduced amount if the property sells, but the terms of that would be interesting. You really have to share part of that with the owner, or otherwise they won’t try to recover any of it until you’re well above the original amount.

  12. 12
    Buck says:

    I think cramdowns would be desirable to return the housing market to rent and income parity quickly, and avoid a multi-year cycle of knifecatchers loosing their downpayments, to the benefit of the lenders. But it should be all lenders, not just the GSEs, and the debtors should have to suffer the BK process to get it.

    http://www.calculatedriskblog.com/2007/10/just-say-yes-to-cram-downs.html

  13. 13
    Ray Pepper says:

    Mark trust me when I say this. Your neighbors scenario is very very widespread. Could be one year or 4. Eventually he walks.

    Kary, the terms have already been outlined in many proposals all resembling 50% to Lender and 50% to homeowner of any appreciation. They are still working on the tax implications.

    Friends—-This will occur—Bank on it! It WILL work for some homeowners. TALK ABOUT DEAL OF A LIFETIME? This is it!! However, turbulent times call for AGGRESSIVE action. The question is WHO will qualify. Investors? I doubt it, but hey——–you never know.

    Mtg cramdown will be sold to the public cautiously and people WILL be screaming for years.

  14. 14
    DaveyDave says:

    A 40% principle reduction seems more reasonable to me… I am not entirely convinced that if it is held to only 30% people will be able to afford a new car.

  15. 15
    S-Crow says:

    Mark & Ray,

    Yes, the walkaways are out there. And there is a lot of “gaming” the system going on. While some of the activity I’m seeing is not necessarily illegal, it certainly could be construed as cowards play. It makes it even more frustrating when it’s people in the business who market themselves as doing the right thing.

  16. 16
    cheapseats says:

    Ray,

    I am not convinced that this WILL happen. Where will this money come from? When you start talking mark downs as a policy it is a giant mess? Will Seattle get 30% when as a whole we aren’t off that far? What good is 30% to homes in Vegas or Florida that are off %50.

    There are way too many variables for this to be a done deal. If they do rush some HUD component of this out it will have minimal impact.

  17. 17
    patient says:

    Now we only need HUD to demand that anyone who ever made a profit on an FHA home sale is liable to pay it back to the gov. No losses, no profits only fair isn’t it? Did anyone say communism? An absolutely insane suggestion if you ask me and I think/hope the american people will torch it.

  18. 18
    Hector says:

    RE: Ray Pepper @ 11

    Ray, don’t forget the ‘Everyone is doing it’ mentatlty. Is the mark left on someone’s credit for foreclosures / short sales / DIL’s going to be as large in 5 years as it was 5 years ago? Probably not, which only encourages folks to walk away.

  19. 19
    Tyler says:

    I think that what Ray has been saying for a while now is right about people not being willing to stay upside down in a house.

    I have a few friends who bought with basically no money down, already saddled with other forms of debt b/c they were afraid they would miss the “opportunity” to ever own their own house. Now that nobody is talking about their home equity rising like it was a stock portfolio, and everyone is talking about keeping their jobs, they are wondering why they would stay in an upside down house.

    There was a big psychological component to the buying frenzy, just look at the amount of money the NAR spent on advertising. I think the next big psychological leap is the acceptance of “losing” a house.

  20. 20
    Genob says:

    May be torn?

    Hell, when my neighbor drives by in his new car, towing his new boat, that he bought with a cash out refinance, while I continued to pay down my mortgage and ignored the “house as ATM” temptation…. and now that money is just handed back to him out of my pocket.. I won’t be torn at all. I’ll be genuinely pissed without reservation. I’ll still be doing yard work while he is waterskiing this summer on my dime?

  21. 21
    CostcoMike says:

    Would it be possible to add restrictions on being approved for a reduction? I am not sure if it would be legal to add the stipulation for those that have excessive assets like: a Boat, extra vehicles (not work related) or have vacation time shares or rentals.

    People that have purchased non-essential items should have to liquidate before being approved. Once they have itemized their assets and sell the items that are not “needed” they can then seek aid. ( I don’t think it should be a principle reduction but aid can be offered in other ways)

  22. 22
    Kary L. Krismer says:

    RE: Tyler @ 19 – Hopefully they’ll talk to a financial counselor before deciding to walk. That could be a decision they’d regret for a long time.

  23. 23
    td says:

    RE: debt retirement treated as taxable income by the IRS

    See IRS Form 982 and the Mortgage Relief Debt Forgiveness Act of 2007 (extended to calendar year 2012 by the Emergency Economic Stabilitization Act of 2008). Principle reduction on primary residence is generally excluded from taxable income.

  24. 24
    Jillayne says:

    regarding FHA delinquencies, HUD just released a Mortgagee Letter this afternoon addressing this problem:

    http://www.hud.gov/offices/adm/hudclips/letters/mortgagee/

    Look for the 2009 Mortgagee Letters and click on “Mortgagee Monitoring.” HUD is going to get tough with lenders who have high default rates. This is a good start. Smaller banks, brokers, and consumer loan companies who lose FHA approval will have a horrible time staying alive in this market.

  25. 25
    Bill says:

    I read the first part of this about how resposible homeowners will be upset that they work their tail off and there neighbor had a principle reduction. What about the people how DO work there tail off and becuse of the housing crisis neighbors are buying homes in the neighborhood 100’s of thousnads of dollars less than what you paid years ago. Shouldnt that responsible homeowner now have the right to a principle reudtcion? He hasnt done anyting wrong, he hasnt stretched himself thin financialy and now he cant sell his property becuse the comp’s in the arae have driven the value of his property into negative equity.
    Most of you are like Obama and congress, you have your heads in the sand!!!

  26. 26
    Mary Cordes says:

    I am for principal reduction on all mortgages as this will spark the economy as all underwater homeowners would feel much more secure about their investment and therefore they would be more inclined to spend a little money without worrying that their home would eventually be worth nothing at all and still have to pay an enormous mortgage for a valueless property.

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