Principal forgiveness is once again on the menu in Washington, this time spurred on by a new report which says taxpayers could save as much as $2.8 billion if troubled borrowers simply owed less.
The problem is that the principal forgiveness — a fancy term for reducing the amount of mortgage debt owed to a lender — is a hotly-debated idea. Even the potential to save nearly $3 billion in taxpayer money is not enough to make debt reductions for troubled borrowers a done deal.
Proponents argue that smaller loan balances are the best way to help people who face foreclosure. Less debt means smaller monthly payments, they say, and smaller monthly payments will mean fewer foreclosures, so let’s encourage principal forgiveness.
Opponents believe that mortgage forgiveness means knocking down loan balances for some borrowers but not others and that’s simply unfair to people who have been paying their mortgage bills.
HAMP Debt Write-Downs
Since 2010, the government’s Home Affordable Modification Program (HAMP) has used principal forgiveness to hold down the foreclosure tide. By the end of 2012 there were 120,000 borrowers who were granted a debt reduction, about one in four HAMP borrowers.
So far HAMP principal reductions have reduced mortgage debt by more than $9.5 billion. That’s a big number and grudgingly-acceptable to lenders only because without the write-downs the losses from foreclosures would have been even greater.
In fact, debt reductions can also been good for taxpayers. A new study by the Congressional Budget Office says an additional 26,000 homeowners could avoid foreclosure while the government would save $2.8 billion if the mortgage forgiveness program is expanded.
Yet as good as debt reductions sound many people are troubled by the idea.
Mike Konczal, writing for the Next New Deal, says debt reductions are widely regarded as a form of government bailout, something without a lot of political popularity.
“If taxpayers just paid off mortgage debts, banks and homeowners would gain a windfall that isn’t directly shared with taxpayers,” explains Konczal.
Treasury Secretary Timothy Geithner says debt reductions for federally-assisted mortgage modifications have only been used as a last resort.
“We made that choice,” he says, “because we thought it would be dramatically more expensive for the American taxpayer, harder to justify, create much greater risk of unfairness, and our program was not designed to do that.”
To get assistance under HAMP a borrower must have a financial hardship and either be delinquent or in danger of falling behind on their mortgage payments.
Someone not paying their bills is plainly delinquent, but what about someone who loses their job but pays their mortgage from savings or retirement funds? They are not delinquent in the usual sense and perhaps not even in danger of falling behind for months or years but their finances are being eroded. Do such maybe-distressed borrowers qualify for a HAMP loan? That decision is made by loan servicers on a case-by-case basis, meaning the answer might be “yes” for some borrowers and “no” for others.
The irony of debt reductions is that a few years ago they were virtually unknown. Now they’re fairly common, an index of just how badly the mortgage financing system has been eroded.