A task force of state attorneys general and banking regulators is calling for principal reductions on "underwater" mortgages in order to stem foreclosures in areas that have experienced steep declines in housing values.

The State Foreclosure Prevention Working Group says that loan modification programs that simply reduce monthly mortgage payments are inadequate in states like California and Florida where a large percentage of homes are significantly underwater. It urges that principal reductions be made a priority in loss mitigation efforts in such areas.

Most loan mods actually increase principal

The group's public report, the first issued in over a year, notes that most mortgage loan modifications actually increase the principal owed by the borrower. It found that while most loan modifications do reduce monthly mortgage payments, over 70 percent increase the loan balance owed by the borrower by rolling delinquent interest and other fees into the loan. This puts the homeowner even further underwater on the loan, which the report notes increases the likelihood of eventual foreclosure.

By contrast, it found that less than 10 percent of all loan modifications reduce the principal owed by 10 percent or more, although noting that figure had more than doubled from March to October 2009. Still, the group said more progress in that direction is needed.

Looming problem with payment-option ARMs

The report says particular attention needs to be paid to reforming payment-option adjustable rate loans, 40 percent of which are currently seriously delinquent. With two-thirds of the $200 billion in outstanding payment-option loans scheduled to reset to fully amortizing loans over the next two years, the report says the resulting "payment shock" will likely push many of these loans into foreclosure.

Representatives of the Obama administration responded to the report by saying the administration does not plan to increase emphasis on principal reductions in loans modified under its Home Affordable Modification Program (HAMP). Nearly one million loan modifications are currently in effect under that program.

Simplified HAMP urged

The task force also called for simplifying the overall HAMP process and reducing the paperwork required, while increasing the transparency of the process to facilitate monitoring. It also called upon the Treasury Department and mortgage servicers to develop new options to help unemployed homeowners. It also called upon states to adopt regulations halting the foreclosure process on any mortgages involved in loss mitigation, noting that some borrowers have lost their homes while being told they were under consideration for a loan modification.

The report says the number of struggling homeowners not receiving foreclosure assistance continues to grow, with only four in 10 seriously delinquent homeowners in any kind of loss mitigation program. It notes there is a growing backlog of loan modification efforts, with a 7-to-1 ratio of loan modifications under consideration to loan modifications approved, with some servicers taking as long as six months to process a loan modification application.

The State Foreclosure Prevention Working Group is made up of representatives of the attorneys general from 12 states and banking regulators from three states and the Conference of State Bank Supervisors. This is the group's fourth report following its creation in 2007.

Published on November 30, 2007