You're underwater on your mortgage and falling behind on payments. You may lose your home. Can you negotiate with your lender to reduce your principal?
Increasingly, the answer is yes, although still only in rare cases.
In what could become a national policy to stem foreclosures, principal reduction is a strategy you should pursue if your lender is open to the idea. It could also give a boost to the U.S. home market, which saw a spurt in existing home sales in December. (link.reuters.com/xap26s)
The potential number of homeowners who could be helped by this strategy is huge: About one in five mortgages are currently underwater, representing about $700 billion in negative equity, the Federal Reserve estimates. Many of those homeowners go into "strategic default" and foreclosure because it makes little or no economic sense to pay on a mortgage that's worth more than their home. Up to 1 million of these homeowners may be allowed to do principal writedowns if state attorneys general reach a settlement with banks over questionable foreclosure practices, said Shaun Donovan, U.S. Housing and Urban Development secretary. (link.reuters.com/vun26s)
The idea of principal reduction to save homeowners from foreclosure is rapidly gaining traction across the country. Bank of America has entered into a pilot program with the Boston non-profit Boston Community Capital to reduce the amount borrowers owe. Trial programs are also under way in Arizona, California and Nevada.
Even the Federal Reserve is endorsing the idea.(link.reuters.com/fak85s)
A CUSHION AND COMMON SENSE
When some $7 trillion in household wealth evaporated in the housing bust, the general economy went down with it - and will stay depressed until Americans have more of a home ownership cushion.
Writedowns, which are common in corporate accounting, could buoy communities and the larger economy. Homeowners who have lost their homes in foreclosures or are saddled with negative equity are spending less in their communities on products and services. They don't remodel, buy furniture or appliances. They have no economic incentive to invest in anything connected with their house.
The policies in place now don't seem to be doing enough. As home values have plummeted - more than 50 percent in some of the most bubble-impacted states - homeowners have lost the ability to refinance because their equity stakes fell "underwater" as their mortgage balances exceeded the value of their homes so they no longer met lending standards. Job loss exacerbated the problem.
The federal government stepped in with a number of loan-modification programs to ease the crunch of foreclosures after the market crashed in 2008. But those programs have largely focused on cutting mortgage rates, which was little help to homeowners, who still largely defaulted on their loans.
One of the largest programs, which goes by the acronym HAMP, offered lower interest rates to 98 percent of its participants, according to a recent Federal Reserve report to the House Financial Services Committee. Yet only 32,000 of those loans were modified with principal reduction - out of some 12 million that are underwater.
"Principal reduction may reduce the incidence of default both by improving a household's financial position, and thus increasing its resilience to economic shocks," the Fed report stated (link.reuters.com/fak85s).
Under the current HAMP program, those underwater homeowners whose mortgage payments exceed 31 percent of gross monthly income and got their loans before January 1, 2009, may qualify for a principal reduction. The one huge catch is that loans owned by Freddie Mac or Fannie Mae, which own about half of U.S. loans, don't qualify.
Unless HAMP or similar programs with Fannie or Freddie are enhanced to promote more principal reductions, you're on your own with your lender. You'll have to ask them directly if they will write down the balance on your mortgage. In most cases, the answer will probably be no, although if more people press their lenders, it may become a more popular option.
Nevertheless, while most bankers would rather send you packing than reduce a loan balance, it may be in their best interest. Foreclosure is costly and they are not in the real estate business. With housing prices expected to be flat this year and foreclosures still climbing, it could be a saving grace for an economy that's still largely house poor.
(Editing by Beth Pinsker Gladstone and Jan Paschal)