Wednesday, June 23, 2010

Finally, a viable principal reduction program.

Today, we got more details on the Treasury's "hardest hit" foreclosure prevention program. There are 4 pieces to the California program (see for a description of the program and the state's proposal for the program to Treasury for more policy wonk details), but the 3rd piece targeting principal reduction is the key. California is receiving $700 million in funding, and expects to spend about 2/3 of the fund on the principal reduction program. Here is a brief description from the proposal (bold added by me):

The Principal Reduction Program (PRP) – CalHFA will provide capital on a matching basis with participating financial institutions to reduce outstanding principal balances of qualifying borrowers with negative equity to market levels needed to prevent avoidable foreclosures and promote sustainable homeownership. The PRP can also be used in conjunction with a loan modification that generates a positive outcome for the homeowner and lender. Funds would be available up to the benefit cap of $50,000 per household or the program balance remaining if the borrower has utilized either one or both of the UMA and/or MRAP programs. The goal of this program is to have a dollar-for-dollar match by the participating lender. In the event that there is less than a 100% match by the participating lender, the assistance will be structured as an interest-free, subordinate loan that may be forgiven over a three-year period. CalHFA will require that the current first mortgage loan-to-value (LTV), after principal reduction, does not fall below 120%.

I like this basic set-up and have endorsed something similar on many occasions. I hope most lenders will participate with the 100% match. Note, that this will not eliminate "underwater" homeowners, but only bring a mortgage balance down to 120% LTV. At this level, homeowners should be able to see a little light at the end of the tunnel and have their mortgage payment be more competive with renting a similar home. Thus, it ought to be enough to stop preventable foreclosures, although certainly not all foreclosures. Also note that the program won't be operational for several months.

I think there needs to be more money in this program (the proposal estimates it will only reach 46,000 California households, and there are something like 300,000 homes in California in the foreclosure process now, and well over a million who are currently delinquent), and the eligibility guidelines are a little too strict. For example it still requires borrowers to be delinquent, to prove "financial hardship" such as loss of job or income to qualify, and the income limits are a little too low.

It also rules out anyone who did a cash-out refinance of their home. I understand the rationale and sentiment against cash-out refinances, but these folks still have the same foreclosure incentive and create the same neighborhood externalities when they do - and not all cash out refinances were for very large amounts or to buy a Hummer. Why is someone who put 5% down and kept cash in the bank to begin with more worthy of help than someone who made a big initial downpayment and later used a cash-out refinance to access the funds. If we must discriminate against refinancers, I suggest making the program less generous for these folks, perhaps 115% LTV for purchase mortgage and 125% for a cash-out refinance. Remember, the point is not just to help those in need but to help the economy and reduce the negative neighborhood externalities that come with foreclosed homes.

I know this won't be popular, but I firmly believe this is a much better approach than the various home buyer tax credits.

If this is successful, perhaps additional funds and expanded eligibility guidelines could come in the future.

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