Mortgage Debt Forgiveness Debated by Economists and Congress

by 31 Jul 2012

(TheNicheReport) -- How much will mortgage debt forgiveness and principal balance write-downs help the housing economy? Such is the current debate weighed by analysts and lawmakers. There are social and economic aspects to consider, and the sheer amount of mortgage debt in the United States continues to place many homeowners at risk. According to a recent opinion piece published by the Wall Street Journal, 24 percent of mortgage borrowers are still underwater -a total of $700 billion. Some level of debt forgiveness will help cure some of this inverted equity, but questions remain as to the impact of the loss.

The argument in favor of a comprehensive plan to write down balances owed on principal mortgages is that it will help homeowners avoid foreclosure. It is difficult to argue against the moral and social benefit of this logic, but the majority investors in the ailing American mortgage market are no longer privately-held entities. Fannie Mae and Freddie Mac are essentially owned by taxpayers; this was a measure undertaken by the federal government after the collapse of the credit markets in 2008. These two entities have already stated the inherent risk in forgiving massive amounts of mortgage debt: taxpayers will have to foot the bill.

The government has already intervened in favor of hundreds of thousands of homeowners with the National Mortgage Foreclosure Settlement Agreement of 2012, but Fannie and Freddie are reticent in their response. The five major mortgage lenders are engaged in figuring out how they can write-down billions of dollars in mortgage balances, but it may take legislation to get Fannie and Freddie to participate. Here are some of the ideas proposed by economists, industry leaders and lawmakers:

Refinancing for Rate and Term at No Cost

This is an option that has already been introduced by Senator Jeff Merkley (D., Oregon), and it looks good on paper. Fannie and Freddie will pick up the closing costs of borrowers who have been able to avoid default despite being underwater. The idea would be to allow these borrowers to refinance into shorter terms; for example, from a 30-year fixed interest rate mortgage to a 15-year fixed, taking advantage of today's record low rates. This refinance would allow equity to seep back into the property and boost market values.

Mortgage Rewards

Under this scheme, borrowers are given a future incentive similar to a balloon reward. Underwater borrowers are encouraged to stay current on their mortgage payments with the hopes to collect a future cash reward valued at up to 10 percent of the mortgage principal. This hedge-like proposal comes from private investors.

Selling Bad Mortgages to Investors

This initiative comes from Fannie and Freddie, and it consists of selling defaulted mortgages to private investors at a discount, with a promise of further incentives if borrowers stay in the distressed homes. This may seem like an offload of risk to private entities, but in the end it will improve the books of Fannie and Freddie and stave off another round of bailout funds from taxpayers.


Should CFPB have more supervision over credit agencies?