The Federal Housing Finance Agency announced a new program to implement principal reduction for seriously delinquent, underwater homeowners who meet the following criteria:
- Are owner-occupants.
- Are at least 90 days delinquent as of March 1, 2016.
- Have an unpaid principal balance of $250,000 or less.
- Have a mark-to-market loan-to-value ratio of more than 115% after capitalization. (1)
The program’s “modification terms include capitalization of outstanding arrearages, an interest rate reduction down to the current market rate, an extension of the loan term to 40 years, and forbearance of principal and/or arrearages up to a certain amount to be converted later to forgiveness.” (1) Once the borrower completes three timely payments, the principal forbearance amount can be forgiven.
This program can help just a small proportion of homeowners who have been underwater on their mortgages. Most importantly, it is being implemented years after the foreclosure crisis swamped the nation’s housing markets. But as can be seen from the criteria above, it is targeted just to homeowners with below-average principal balances on their mortgages and who are severely underwater. There are all sorts of political reasons that principal reduction was not a key component of the post-crisis housing finance reform agenda. But it is worth asking now — should we deploy it more quickly in the next crisis? What would be the principled reasons for doing that?
Many argued that principal forgiveness would reward homeowners for making bad, even immoral, decisions. With the benefit of hindsight, it would have been better to put that questions aside and ask what the best policy option for the country would have been. If outstanding principal balances could have been aligned more closely to the new normal of the post-financial crisis economy, the recovery could have proceeded more quickly.
Now would be the time for the FHFA to implement regulations to deal with the next great recession. If principal forgiveness makes sense under certain conditions, let’s identify them now and then have an easier time of it down the road.