The Obama administration's signature foreclosure-prevention program is likely to be a failure and has not done enough to help struggling homeowners who owe more on their mortgage than their home is worth, according to a scathing new report by a government watchdog. And the program may even be pushing these homeowners further underwater.
The average homeowner may owe their lender as much as two-and-a-half times more than the home is worth, the Office of the Special Inspector General for the Troubled Asset Relief Program states in its new report examining the administration's year-old $75 billion Home Affordable Modification Program, citing November data from Fannie Mae.
Yet the program doesn't address this problem of negative equity -- commonly referred to as being "underwater" -- according to the report. The administration's effort has been touted as a way to stem the rising tide of foreclosures by reducing monthly payments for up to four million troubled borrowers.
But one essential method of helping underwater homeowners -- principal reductions -- has not been addressed by the program. Mortgage servicers forgave principal on less than two percent of HAMP trial loans, the report notes. But before HAMP, 10 percent of servicer-sponsored mortgage modifications forgave principal, according to the report. Servicers are incentivized to lower monthly payments by getting cash for every sustainable mortgage modification.
"HAMP allows principal reduction, but it is not typically implemented in practice," the report states.
This data had never been publicly disclosed prior to Tuesday.
About a quarter of all homeowners with a mortgage are currently underwater, according to real estate research firm First American CoreLogic. The watchdog report notes that underwater homeowners represent about half of all foreclosures.
The lack of principal reductions, which the report notes is the "primary method of quickly addressing negative equity," may lead to homeowners walking away from their mortgages. Strategically defaulting on a mortgage -- being able to afford the mortgage, yet voluntarily choosing to default -- "usually occurs when the home's value is substantially lower than the mortgage value," the report notes.
"Although relatively common in commercial real estate, it has been widely reported that homeowners may be increasingly more likely to strategically default on their homes," according to the report. "Given the amount of negative equity in the mortgages under trial modifications, strategic default may become a factor in HAMP re-defaults, as borrowers decide that it makes more economic sense for them to walk away from their mortgages, and rent at a lower cost, rather than continue to make higher payments that may never result in them obtaining equity in their mortgage."
A recent report by state attorneys general and state bank supervisors noted that more than 70 percent of mortgage modifications result in an increase in the principal amount owed.
"The evidence is irrefutable. Negative equity is the most important predictor of default," said noted mortgage bond analyst Laurie Goodman of Amherst Securities before a Congressional panel in December.
Paul Leonard, the Center for Responsible Lending's California office director, said that he wasn't surprised by the new Treasury Department data, noting that many of the mortgage modifications are occurring in markets that have experienced steep declines in house prices.
However, because the average HAMP homeowner is underwater it will inevitably lead to "higher than both expected and desired re-default rates," he said. Homeowners deeply underwater are "more like long-term renters than normal equity-appreciating homeowners," he said.
"It supports the case for principal reductions, particularly in markets that have experienced deep price declines," said Leonard.
According to available data, not only is the average homeowner in the Obama administration's primary foreclosure-prevention program currently underwater, but is also very likely to end up being pushed further underwater by the administration's efforts.
"While the focus of the program remains affordability, Treasury continues to study ideas that will enhance, albeit modestly, program outcomes for...underwater borrowers," Assistant Secretary for Financial Stability Herbert M. Allison, Jr. wrote in a March 22 letter in response to SIGTARP's report.
The administration recently announced a $1.5 billion pilot program for the five states that have had the biggest declines in home prices to encourage state officials to experiment with various proposals to reduce the foreclosure rate. Those states are free to implement widespread principal cuts.
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