Borrowers Want Big Mortgage Reductions, Poll Says

NEW YORK ( TheStreet) -- Homeowners struggling with mortgages that exceed the value of their homes would like to see more policy efforts directed towards principal reduction compared to any other form of mortgage relief, according to a poll run by TheStreet.

Over the past six months the Obama administration has introduced a slew of measures designed to provide some relief to borrowers, particularly those stuck with mortgages that exceeds the value of their homes.

From revising the guidelines under HAMP (Home Affordable Modification Program) and HARP(Home Affordable Refinance Program) to introducing legislation that would allow all borrowers current on their payments to refinance loans through the Federal Housing Administration at low interest rates to forcing banks to offer $10 billion in principal reductions under a nationwide mortgage settlement , policymakers have been trying to ease the burden on "responsible" homeowners.

Principal reductions have been a particularly controversial form of mortgage relief that the government has been pushing. The rationale being that reducing the principal on mortgages helps reduce the negative equity on a home. Currently, there is nearly $700 billion of negative equity in the housing market- that is, where the borrower owes more than a home is worth.

Negative equity makes it tough for borrowers to refinance their homes even as interest rates decline and makes it harder to sell their homes either in an effort to repay their debt or in order to pursue job opportunities in another location. This results in more defaults, weighing on the housing market and the economy.

Still, the Federal Housing Finance Agency (FHFA), conservator of Fannie Mae and Freddie Mac, which underwrites the majority of the nation's mortgages, remains fundamentally opposed to the idea of reducing the principal on a mortgage because it means the housing giants will have to absorb more losses, which will be ultimately borne by the taxpayer. Fannie Mae and Freddie Mac were bailed out in 2008 and have cost taxpayers more than $150 billion to date.

FHFA director Edward DeMarco insists that other forms of mortgage modifications such as principal forbearance, interest rate reductions and term extensions are equally effective in reducing monthly payments for borrowers and still minimize overall losses to Fannie and Freddie and the taxpayer.

DeMarco also worries that principal reductions will create a moral hazard. Right now, 80% of Fannie and Freddie's borrowers with negative equity are still current on their loans. Making blanket principal reductions might encourage those who are current on their loans to default, in order to be eligible for a principal reduction.

Still, in a poll run by TheStreet last week, more than half of the voters said they would prefer principal reductions that would help restore equity in their homes. They were even willing to work with tradeoffs, agreeing to sacrifice a portion of future gains on their home value with lenders or investors.

About 28% still felt that making more borrowers eligible for refinancing and lowering the overall costs of refinancing such as upfront fees would be a welcome form of relief. The Obama administration has announced legislation that would allow borrowers who are current on their payments to refinance at low interest rates and save upto $3,000 a month through a new program run by the FHA. The program would be financed by a fee on the biggest banks. Most do not expect the deal to win congress approval.

About 18% felt that they would do just fine with more modifications that would lower their monthly payments through term extensions or forbearance.

Last week, the Justice Department, the Department of Housing and Urban Development and 49 state attorneys general filed the $26 billion foreclosure settlement with the court. The agreement detailed new servicing standards for banks and spelled out ways in which banks will compensate borrowers for violating procedures in the foreclosure process. The settlement envisages at least $10 billion by way of principal reductions, $3 billion in refinancing and $7 billion towards various alternatives to foreclosure such as short sales and deeds in lieu of foreclosure.

Bank of America ( BAC), under its own agreement with the states, has agreed to cut principals on underwater mortgages of 200,000 borrowers by as much as $100,0000. Ally Financial has also agreed to broader cuts. Meanwhile, Citigroup ( C), JPMorgan Chase ( JPM)and Wells Fargo ( WFC) will slash the principal of eligible borrowers to at least 120% of the market value of the property, which works out to an average of $20,000 in principal reductions per borrower.

Banks have so far adopted principal reductions at a very slow pace on their own.

During 2011,Bank of America completed over 225,000 customer loan modifications with a total unpaid principal balance of approximately $49.9 billion, including approximately 104,000 permanent modifications under the government's Making Home Affordable Program.

Of the loan modifications completed in 2011, the most common types of modifications was a combination of rate reduction and capitalization of past due amounts which represent 60 percent of the volume of modifications completed in 2011, while principal forbearance represented 19 percent, principal reductions and forgiveness represented six percent and capitalization of past due amounts represented eight percent, according to the bank's 10K.

JPMorgan permanently modified about 25000 residential real estate loans, of which 11% was in the form of principal forgiveness, while the bulk was in the form of interest rate concessions and term extensions.

--Written by Shanthi Bharatwaj in New York

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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