Center for American Progress

Principal Reduction Will Help Prevent Foreclosures
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Principal Reduction Will Help Prevent Foreclosures

Fannie Mae or Freddie Mac, the country’s two biggest mortgage finance companies, have yet to embrace one option—principal reduction—as a viable foreclosure mitigation tool.

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More than five years into what is arguably the worst foreclosure crisis in American history, millions of families are still at serious risk of losing their homes. Nearly one in four homeowners is “underwater,” meaning they owe more on their mortgage than their home is worth, and more than 7 million homes are still in the foreclosure pipeline, according to analysis from Morgan Stanley. In fact, some analysts predict we’re only halfway through the crisis.

The big question before lenders, investors, and policymakers today is how to avoid another wave of costly and economy-crushing foreclosures. There are several ways to lower an at-risk borrower’s monthly payments and increase the chance of repayment: refinancing to today’s historically low interest rates, extending the loan’s terms, modifying the interest rate, deferring payments, or lowering the amount the borrower actually owes on the loan—so-called “principal reduction.” In most cases the lender or mortgage investor responsible for the loan considers all of these options when deciding which intervention is best for the specific borrower.

That is, unless the loan is owned or guaranteed by Fannie Mae or Freddie Mac, the country’s two biggest mortgage finance companies. Fannie and Freddie have yet to embrace one option—principal reduction—as a viable foreclosure mitigation tool.

In fact the two mortgage giants, which are now operating under government conservatorship, are forbidden from lowering principal on any mortgages they own or guarantee by their regulator, the Federal Housing Finance Agency, or FHFA. That’s the case despite a growing consensus among economists, investors, academics, and consumer advocates that principal reduction is often the most costeffective way to avoid unnecessary foreclosure for certain groups of borrowers.

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