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 $190 billion of taxpayer money.
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 programs were designed to help only borrowers on the verge of losing their homes, in effect penalizing those who kept paying, according to homeowner advocates such as Julia Gordon, director of housing finance and policy at the Center for American Progress in Washington. In some cases, servicers have advised borrowers to stop making their mortgage payments to qualify for help, leading to evictions if their applications are denied, Gordon said.
U.S. residential real estate lost about a third of its value after home 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 about 7% in 2012 from 2010, when it fell 5% from the year before.
There are about 7 million underwater properties, worth less than the mortgages on them, down from 11 million in 2011, according to JPMorgan Chase & Co. Within two years, the number of upside-down home loans could drop to 4 million, the New York bank said.
“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 $190 billion in taxpayer aid since they were taken into conservatorship in September of 2008 when investments in risky loans pushed them to the brink of insolvency. They’ve paid a combined $50 billion in dividends back to the U.S. Treasury. The companies own or guarantee $5.2 trillion of mortgages, more than half the outstanding U.S. 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, the homeowners’ advocate, argues that while the change may be late, it’s 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’ll recover when the property is sold, she said.
“Fannie and Freddie are finally recognizing 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 neighborhood,” Gordon said.
The new programs 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 programs don’t require borrowers to be turned down for a modification before applying, as does the Treasury-run Home Affordable Foreclosure Alternative program, or Hafa.
The companies changed their programs in tandem 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 Corp. However, if borrowers keep current with their payments during the process, they won’t take additional hits for delinquencies.
To qualify for the programs, borrowers are required to have a 55% debt-to-income ratio -- meaning 55% of their monthly gross income goes to paying debt. To be eligible, homeowners have to document a hardship, such as illness, for Fannie Mae and Freddie Mac to consider the deal. For a deed-in-lieu transactions, servicers must confirm the property is being left in good condition.
“The goal is to make sure people who have suffered a hardship have the appropriate options to prevent foreclosure,” said Andrew Wilson, spokesman for Washington-based Fannie Mae. The company has renamed its deed-in-lieu program, now calling it mortgage releases.
While Fannie Mae and Freddie Mac forgive any remaining first-lien obligations, they can’t control what the holders of second mortgages do. Last year they said servicers can offer the owners of home equity debt up to $6,000 to release borrowers from requirements to pay off those loans.
“The second-lien holder gets a say -- they don’t have to release the title,” said Mark Goldman, a mortgage broker at C2 Financial Corp. in San Diego. “It can get complicated when other people have a stake in a property.”
Fannie Mae and Freddie Mac may require repayment of some of the shortfall between the value of the home and the mortgage balance -- if the borrowers have the means. Homeowners who apply for deed-in-lieu transactions may be asked to make cash contributions of up to 20% of their financial reserves, excluding retirement accounts, according to the guidelines.
Or, they may be asked to sign a promissory note for future no-interest repayments. The amount and terms can be negotiated, according to the servicer guidelines.
Borrowers are allowed to have a newly originated mortgage on another property if they are moving for a new job or if they are in the military and moving to a new station. Also, they can have a vacation home and still apply for assistance for their primary residence.
“I don’t have a huge amount of sympathy for someone who says they need help from Fannie and Freddie when they still have a vacation home,” said Dean Baker, co-director of the Center for Economic and Policy Research in Washington.
Even if borrowers pay a portion of their loan’s shortfall, it may be a better deal than just walking away from the property. Almost two-thirds of mortgages are held in so-called recourse states that permit lenders to chase homeowners for the full difference between the value of their property and the loan principal, known as a deficiency.
In non-recourse states, many home loans are eligible for deficiency judgments if they have been refinanced. Two weeks ago, Congress extended a law that grants tax-free status to the forgiven portions of mortgages, which normally would be considered income for the borrower.
“There are lots of families who are trapped in their homes,” said Gordon, of the Center for American Progress. “They need a way to get out.”