The United States is experiencing a housing crisis. Too many Americans have to spend an outsized portion of their income on their mortgage payments or are unable to pay it and are at risk of being foreclosed upon.
That might be news to people who thought the problems in housing had already been solved, but tens of millions of households are desperate to reduce the amount of money they're spending on their homes and avoid foreclosure.
There are things that can be done to reduce the amount of money people are spending on their mortgage payments. The best way is by reducing the principal balance on the loan.
The Problem of Negative Equity
Millions of homeowners owe more on their home than it is worth, which is called negative equity. Millions more are in effective negative equity, which means they don't have enough equity to sell their homes and pay closing costs and make a down payment on another house. About 40% of homeowners fall into one of those two groups.
A major reason for negative equity is that many mortgage loans were obtained on homes at inflated prices before the housing market crash. When the bubble burst and home values came back down to earth, but the balance on the loan remains inflated.
A homeowner who has negative equity but can afford to pay their mortgage isn't in trouble. They're just spending more than than they ideally should. Eventually the value of the home should rise enough that they are out of negative equity or they pay their way out of it.
The trouble is when you don't have the money to pay the mortgage on a property that's in negative equity. You can't afford the home but also aren't able to get rid of the home through a regular sale. Having a home in negative equity that you can't afford is like being stuck between a rock and a hard place. You'd need to get a short sale or deed in lieu agreement to leave without foreclosure.
Reducing principal for borrowers who can't afford a loan that's worth more than the property it secures makes all the sense in the world. It only seems fair to bring the loan balance in line with the current market value of the home, especially considering that the average homeowner had nothing to do with causing the housing crash. It helps the borrower keep their home with a more affordable payment and lets the lender avoid costly foreclosure proceedings. So, why hasn't it happened?
Loan Modifications and Principal Reductions
Principal reductions have been happening through loan modifications, but nowhere near the number of people who need help have been getting it.
A loan modification involves changing one or more terms to your existing mortgage loan. Like a refinance, a loan modification can lower the interest rate and extend the loan term to bring the monthly payment down. Unlike a refinance there's no credit check or closing costs, and it's possible to get your principal reduced.
Lenders who give modifications through the federal government's Home Affordable Modification Program (HAMP) are paid money for each mortgage they modify. The typical modification can involve a principal reduction, but they are more the exception than the rule.
Less than a million people have received a HAMP loan modification, which is far less than the government had hoped. And a third of people who have received one have redefaulted. HAMP has helped some, but it's also been a disappointment. A lot of people are still in desperate need of help.
Given the nature of the help that's needed, principal reductions are a solution that makes perfect sense. Reducing the mortgage debt carried by families to a level in line with their home's current value would not only help them avoid foreclosure, but would also allow them to spend money elsewhere in the economy.
Fannie Mae recently announced that they would be rolling out their principal reducing modification program, but only about 22,000 homeowners are expected to be eligible. Widespread principal reductions are needed to solve the housing crisis.
Many people have said that the government should do more to incentivize lenders to give principal reductions or give cash to homeowners instead of their bank, and that every seriously underwater homeowner should have a way to reduce their principal. The government's estimates from the Congressional Budget Office says doing so would give favorable outcomes.
A recent CNBC article cites the CBO's report:
“We know from the government's own research that large-scale principal reduction works. Three years ago, the nonpartisan Congressional Budget Office (CBO) — the research arm of Congress — found that, had Fannie and Freddie embraced principal reduction after the 2008 crash, they would have foreclosed upon fewer families, saved taxpayer dollars and boosted economic growth.”
That would have been nice, but don't be discouraged that things aren't as good as they could be if you're one of the many homeowners who needs assistance. Principal reductions are possible with loan modifications, and a change to the rate and term of your mortgage alone can still lower your payment enough to help you keep your home. HAMP is expiring at the end of 2016, so if you need help, the time to act is now.
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