PRINCIPAL REDUCTIONS – WILL THE BANK GUARANTEE THE VALUE OF YOUR HOME?

In a briefing by Credit Suisse this week, the financial giant’s opinion was that reducing principal balances of underwater mortgages is a risky idea that has not been shown to keep underwater borrowers from later defaults.  In my practice as a Florida real estate lawyer, that opinion flies in the face of borrower sentiment.  The guiding force in the Credit Suisse statement seems to be the “moral hazard” argument, coupled with statistics about the failure of principal reductions helping homeowners.

As reported by Bloomberg News, Dale Westhoff on behalf of Credit Suisse said that of the 11 million “underwater” homeowners, about 6.5 million have never missed a payment and 2 million more are making on-time payments after delinquency.  He said that widespread principal reductions may drive defaults much, much higher as borrowers seek the aid.  But he also said that such wholesale principal reductions have never been done before and the associated risk is unknown.  Furthering that argument, he said that if principal reductions are offered, it may create the concept that the lenders are guaranteeing the value of homes.

Others don’t share the same view.  I for one find that 50% of those that seek my assistance have decided that without a meaningful principal reduction, they are merely overpaying rent and having a debt obligation as well.  This sentiment was predicted as far back as 2001. [See my article A HOME WITHOUT EQUITY IS JUST A RENTAL WITH DEBT]. 

While Fannie Mae and Freddie Mac maintain a no principal reduction policy, New York Federal Reserve Bank President William Dudley said this month that without a significant turnaround in home prices and employment, a substantial portion of deeply underwater home loans (as in Florida) will ultimately default absent a realignment of principal to market value.  This concurs with the findings I make in my office everyday by speaking with troubled borrowers.

Will the argument that principal reductions will bring out a flood of applications for similar aid hold true – I think the estimates of that flood are probably understated! - At least here in Florida.

The problem has been quantified by specialists as needing to avoid 8 to 10 million more distressed property sales through the application of principal reductions.  Although some programs for “short refinancing” are in effect, with 125% caps that is not enough in the hardest hit states – where the market value drops are far greater and the bulk of the problem loans exist.

From the macro viewpoint, short sale guru (as in billion dollar bets that the mortgage bonds would fail) Greg Lippmann wonders what the big deal is – since investors write down their portfolios anyway and have been doing business like this for years.

 It seems to me that writing down the loan at the borrower level will have the added benefit of lowering losses on the loan underlying the mortgage bonds, therefore stabilizing that market.  Without the help to the first tier borrower – the homeowner – the homeowners’ later default simply makes the foundation upon which the bonds are created subject to disintegration.  If we don’t see principal reductions then this is going to be a very slow recovery.  If we do see principal reductions we are liable to experience “non-qualified” borrower revolt and a new era of lending and doing business a very different way.

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Copyright 2012 Richard P. Zaretsky, Esq.

Be sure to contact your own attorney for your state laws, and always consult your own attorney on any legal decision you need to make. This article is for information purposes and is not specific advice to any one reader. Richard Zaretsky, Esq., RICHARD P. ZARETSKY P.A. ATTORNEYS AT LAW, 1655 PALM BEACH LAKES BLVD, SUITE 900, WEST PALM BEACH, FLORIDA 33401, PHONE 561 689 6660 [email protected] - FLORIDA BAR BOARD CERTIFIED IN REAL ESTATE LAW - We assist Brokers and Sellers with Short Sales and Modifications and Consult with Brokers and Sellers Nationwide! [email protected] Website www.Florida-Counsel.com.

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Comment by Richard Zaretsky on January 28, 2012 at 9:03pm

Mike - good thought, but the tax implication is the same for the short sale as the principal reduction as both are forgiveness of income scenarios. Both might qualify under the 2007 Mortgage Debt Forgiveness Act to disregard the forgiven debt as income.

Comment by Michael Schneider on January 28, 2012 at 9:06am

I think principal write down is a bit of an illusion.  It won't really matter to the housing market.

Why?  Because, if my mortgage is not affordable for me, I already have much better than principal write down to 110%.  I have my own principal write down to 88%--a short sale.  These are big numbers.  On a $300,000 debt on a house worth $200,000, principal write down leaves me with a $40,000 liability. Bad deal.

If my mortgage is affordable, principal write down is a nice subsidy, without public benefit.  Besides, if I choose to exercise my option, I can probably match this, or perhaps do better.  Short sell and negotiate the deficiency.

In summary, it won't make much difference to the housing market.  We just subsidize holder of affordable mortgages by transferring $400 Billion from bondholders to debtors.

Bad plan.  Makes no sense.

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