US mortgage giants offer incentive to walk away from home loan debt woes
US mortgage giants will let some borrowers who kept up payments but found themselves in negative equity give up their properties
Fannie Mae and Freddie Mac will let some borrowers who kept up payments as their homes lost value erase their debts by giving up the properties, helping Americans escape underwater loans while adding to losses at the mortgage giants bailed out with US$190 billion of taxpayer money.
In Hong Kong, underwater loans are known as negative equity when homes are worth less than the mortgages on them.
Non-delinquent borrowers with illness, job changes or other reasons they need to move will become eligible in March to apply for a so-called deed-in-lieu transaction that erases the shortfall between a property's value and the size of its mortgage. It follows a change in November that lets on-time borrowers sell properties for less than they owe, known as short sales, wiping out the remaining mortgage debt. Normally, the lenders could pursue people to recoup their losses.
"It's an extraordinarily generous approach for companies still in debt to American taxpayers," said Phillip Swagel, a professor at the University of Maryland's School of Public Policy in College Park, Maryland. "We're giving people an incentive to walk away, right when the housing market is starting to right itself."
Previous foreclosure-prevention programmes were designed to help only borrowers on the verge of losing their homes, in effect penalising those who kept paying, according to homeowner advocates such as Julia Gordon, director of housing finance and policy at the Centre for American Progress in Washington. In some cases, servicers advised borrowers to stop making mortgage payments to qualify for help, leading to evictions if their applications were denied, Gordon said.
US homes lost about a third of their value after prices peaked in 2006. The collapse of the mortgage market in 2008 sparked a global financial meltdown and created the worst foreclosure crisis since the Great Depression. In the last year, home prices have started to revive. The median price of an existing home rose 7 per cent last year from 2010.
There are about 7 million underwater properties, worth less than the mortgages on them, down from 11 million in 2011, according to JPMorgan Chase. Within two years, the number of upside-down home loans could drop to four million.
"Fannie and Freddie are playing catch-up, making these changes when defaults are falling and the housing market is coming back to some extent," said Kurt Eggert, a professor at Chapman University School of Law in Orange, California. "It should have happened a long time ago."
Fannie Mae and Freddie Mac have drawn almost US$190 billion in taxpayer aid since they were taken into conservatorship in September 2008 when investments in risky loans pushed them to the brink of insolvency. They have paid a combined US$50 billion in dividends back to the US Treasury. The companies own or guarantee US$5.2 trillion of mortgages, more than half the outstanding US home loans.
"The government is saying you can just turn in your home and we're not going to come after you for the money you still owe," said Peter Schiff, chief executive officer of Connecticut-based brokerage firm Euro Pacific Capital. "Some of these are going to be people who might otherwise have stayed in their homes and kept making payments."
Gordon says while the change may be late, it is still good policy.
The deed-in-lieu transactions, which require homeowners to leave properties in good condition, preserve the value of homes by preventing owners from abandoning them to take a new job or cope with an illness, Gordon said. Vacant and dilapidated real estate drags down values of nearby houses, increases expenses for Fannie Mae and Freddie Mac, and reduces the amount they will recover when the property is sold, she said.
"Fannie and Freddie are finally recognising that some people are stuck in their homes," she said. "There are a lot of families who need to move who can't do it if they're going to have debt hanging over their heads. There's no winner when someone is forced to default on their mortgage - not the investor, not the homeowner, and certainly not the neighbourhood."
The new programmes are separate from the government's Making Home Affordable foreclosure-prevention efforts that require homeowners to be in or near default. The Fannie Mae and Freddie Mac programmes don't require borrowers to be turned down for a modification before applying, as does the Treasury-run Home Affordable Foreclosure Alternative programme.
The companies changed their programmes to satisfy a directive from their regulator, the Federal Housing Finance Agency, to align some of their servicing rules, said Brad German, a spokesman for McLean, Virginia-based Freddie Mac. While Freddie Mac previously accepted applications from on-time borrowers, "approvals were rare", German said.
For either a deed-in-lieu or a short sale, the failure to pay off the full mortgage balance will be reported to credit bureaus even as the amount is forgiven. The effect on scores will be nearly as bad as foreclosures, according to Fair Isaac. However, if borrowers keep pace with payments during the process, they won't take additional hits for delinquencies.