Principal Cuts May Prevent Foreclosures

January 14, 2010

Source: Bloomberg, John Gittelsohn and Prashant Gopal

At least 7 million borrowers will lose their homes this year and next unless there is a broad increase in property values or lenders become much more willing to cut the principal on mortgage loans, an analyst with Amherst Securities Group told the U.S. House Financial Services Committee last month.

That testimony has motivated Federal Deposit Insurance Corp. Chair Sheila Blair to consider incentives for lenders to cut principal on $45 billion in mortgages her agency has acquired from seized banks.

"We're looking now at whether we should provide some further loss-sharing for principal write downs," says Bair. "Now you're in a situation where even the good mortgages are going bad because people are losing their jobs."

While principal reductions are rare, some banks are doing them. In the third quarter of 2009, about 21,000 home loans were modified by reducing the principal, according to Mortgage Metrics, a government publication.

Mark Zandi, the chief economist for Moody's Economy.com, suggests that banks receive a federal match of $1 for every $2 in principal reductions they offer to home owners.

"You're not going to wipe out all the borrowers' negative equity," he says. "This just gives them enough hope to get them committed again."

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