There’s a new plan floating around in Washington, a way to end the foreclosure crisis or at least part of it. The thought of the day is that we can keep more people in their homes if we simply reduce the size of their mortgage debt.
Principle forgiveness sounds pretty good. This is essentially the approach recently taken with Greece, a nation which agreed to repay its bills — but only after those debts were reduced by 53.5 percent.
According to Edward J DeMarco, acting head of the Federal Finance Housing Agency, the government entity which now oversees Fannie Mae and Freddie Mac, “principal forbearance has become an important part of loan modifications for underwater borrowers, increasing from 11 percent of total modifications in 2010 to 26 percent in 2011.”
Notice that DeMarco is not talking about “principal forgiveness,” instead he’s describing something called “principal forbearance.”
There’s a difference.
With principal “forgiveness” the borrower owes $100,000 and the debt might be reduced to $80,000. The smaller debt leads to lower monthly payments and hopefully no additional losses for the lender.
With “forbearance” the borrower owes $100,000 and continues to owe $100,000. “Forbearance” turns out to be a unique form of “shared appreciation,” something where — as DeMarco explains — “the lender allows the homeowner to defer payment of a portion of the principal of their loan until they sell their home or refinance their loan, and pay no interest on the deferred principal.”
Forbearance can be seen as a kind of hedging. The lender hopes that by keeping its claim in place it might actually collect more of the debt than with forgiveness — and maybe all of the debt if prices rise sufficiently over time.
One attraction of principal forbearance is that it defers the final accounting for years and years. If home values go up lenders get 100 percent of any appreciation until the total amount of the debt has been repaid. Only after lenders have been fully compensated will homeowners see any sale profits. If a lot of distressed owners use principal forbearance it means lenders will be able to downplay real estate losses for years and with such time build up assets and limit damage.
For borrowers principal forbearance works well for those who wish to stay in place. But let’s be honest, individuals who participate in principal forbearance are not “homeowners” in the classical sense. Their odds of owning a home free-and-clear of all debt are in the range of a lottery ticket. Instead, they can be seen as “semi-renters” or “semi-owners,” a new class of real estate in-betweeners, individuals with names on the title who receive tax breaks but also individuals who have something less than total ownership.
For distressed borrowers either forbearance or forgiveness is a better option than foreclosure and the loss of a home. But will either idea materially reduce the inventory of foreclosed homes?
$7 Trillion In Losses
DeMarco says if some form of principal reduction is tried that losses to Fannie Mae and Freddie Mac “are expected to be $55.5 billion with principal forbearance and $53.7 billion with principal forgiveness.” The better choice for the government is principal forbearance but the real benefit to the economy is limited for four reasons.
First, since 2005 the equity in American homes has fallen by $7 trillion according to DeMarco. There are roughly 12 million homes underwater so $53 billion or $55 billion in principal reductions will only make a small dent in the foreclosure problem
Second, most potential losses have nothing to do with Fannie Mae or Freddie Mac. Despite headlines and commentary to the contrary, DeMarco points out that “Fannie Mae and Freddie Mac own or guarantee 60 percent of mortgages outstanding but they account for only 29 percent of seriously delinquent loans.”
Seen the other way, private lenders hold 40 percent of all home loans and those mortgages represent 71 percent of all troubled mortgages.
Third, mortgage losses are at the heart of a debate. Is helping troubled homeowners the right approach or does such assistance encourage other homeowners to stop payments, to walk-away from their mortgages?
Fourth, who pays for principal write-downs? Those who originated the loans? Those who took mortgages and packaged them into mortgage-backed securities? Those who invested in mortgage-backed securities? The courts are filled with cases trying to figure out the answers.
Buyers & Investors
Short sales and foreclosures are now a huge part of the marketplace — 34 percent according to the National Association of Realtors. NAR president Moe Veissi says “when markets are balanced, we normally see prices rise one to two percentage points above the rate of inflation, but foreclosures and short sales are holding back median prices.”
Translation: Distressed homes are a big part of the market. Because they sell at “deep discount” according to NAR, they impact home prices generally.
That said, the inventory of distressed properties is not static. It grows and shrinks and has local concentrations. Without maintenance, distressed homes become increasingly costly relics, some beyond repair.
The result is that not only is the number of distressed properties important but so is their age. RealtyTrac points out that “U.S. properties foreclosed in the first quarter took an average of 370 days to complete the foreclosure process, up from 348 days in the previous quarter and the highest average number of days going back to the first quarter of 2007.”
Amazingly, it now takes — on average — more than 1,000 days to complete a foreclosure in New York state.
“We still have not seen an end to the robo-signing and show-me-the-note controversies which have slowed or stopped foreclosures in many markets,” said RealtyTrac vice president Daren Blomquist. “As these issues become resolved we can expect that the pace of foreclosures will again increase as delayed filings go forward. We should also expect more rental demand as former homeowners seek new accommodations.”
Combine low interest rates with rising rental demand and discounted purchase prices and it’s little wonder that investors now buy almost a quarter of all existing homes. Simply put we continue to have a buyers market in most areas, markets filled with attractive short sales, foreclosures and REOs.
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Peter G. Miller is syndicated in newspapers nationwide and operates the consumer real estate site, OurBroker.com.