The Principal Deduction Debate

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Those that support mortgage prime deduction strongly believe it will counteract the housing crisis. Those opposed view it as one more handout that the nation’s already burdened taxpayers will be left with. Furthermore, opponents predict that it will set off more loan defaults.

The Amherst Securities Group reports that, since 2010, the rate of principal reductions that went through without government guarantees has jumped from 11 percent to 40 percent. Due to the high number of illegal foreclosures, five of the country’s heavy hitters, including Wells Fargo and Bank of America, were charged to pay $17 billion to borrowers in distress. The $25 billion settlement was reached in February, and those five lenders are to make payments to distressed homeowners in the form of loan modifications. Most of them will be principal write-downs.

Although it should come as a relief for scores of underwater borrowers on the brink of default, the truth is that not so many can qualify.

The main problem lies in the question of, “Who owns your mortgage?”

Because of the terms of the settlement, if the mortgage is not owned by one of the major banks, it is highly unlikely that those borrowers will qualify for assistance. Jack Guttentag, an emeritus professor of finance from the Wharton School observed, “Although it seems unfair, borrowers don’t have a say about who ends up owning their loan.”

An August 2nd article posted on site for the public policy research agency, the Center for American Progress, noted that currently, Freddie, Fannie, and the FHA back more than 90 percent of all home loans. That’s because the shell-shocked mortgage industry now shies away from those loans that do not come with a government backed safety net. And guess what? The majority of those are not eligible for the principal deduction deal.

The issue is paradoxical, the fear is that because so many do not qualify, they resort to defaulting, and then voila` they become eligible! This is called “moral hazard” and is cited by the Federal Housing Finance Agency’s (FHFA) director, Edward DeMarco as the main reason why he has not allowed the three federally backed programs to use principal reduction.

There is however, a government-sponsored program funded by taxpayers that subsidizes modifications of distressed mortgages. It is the Home Affordable Modification program or HAMP. Although the larger lenders employ HAMP, American taxpayers actually foot part of the bill.

Mark Calabria, director of Financial Regulation Studies at the conservative Cato Institute stated, “It’s a wash, you’re redistributing income instead of creating it.”

So, as the blame game continues, many point fingers at the big five lenders and say they knew what they were doing, they also knew the government would bail them out. Since it is too late to change that situation, many are urging the FHFA to participate in a principal deduction program. The FHFA continues to resist and cites their studies indicate doing so would cost US taxpayers billions. However, a recent Wall Street Journal article reported that even after accounting for the cost of HAMP subsidies paid by taxpayers, a debt-forgiveness program would save the public $1 billion.

And the debate continues…

Anna Platz is an Editor at ForTheBestRate.com, a leading mortgage rate research website, as well as the Lead Contributor to GoodCentsSavings.com, a blog about budgeting and personal finance. Anna is immersed in the world of real estate, mortgage, and home financing and is here to provide valuable resources for homeowners and soon-to-be-homeowners on buying and selling real estate, researching a mortgage broker or lender, and securing a home loan. Check back often for news, updates, and remember that you can find today's current mortgage rates at ForTheBestRate.com. My Google Profile+

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