Despite Rising Home Prices, We Still Need Principal Reduction

Home prices have been rising rapidly in recent months, which has led to a modest reduction in the number of homeowners who are “underwater,” or owe more on their mortgage than their home is worth. This welcome development has led some observers to suggest that there is no longer a need for policy solutions that target underwater homeowners, such as reducing the principal balances on their mortgages as part of a loan modification.

But it’s way too early to break out the champagne. More than 10.4 million homes — or over 20 percent of mortgages — are still underwater, and almost 10 percent of mortgages are underwater by more than 25% of their home’s values.

While home prices have risen by about 11 percent in the past year, they are still 27 percent lower than their peak at the height of the housing bubble. The rebound also is extremely uneven, with prices increasing at dramatically different rates in different areas, and even in different neighborhoods within cities.

It is also not clear whether these gains will be sustainable. Home price increases are the steepest in the cities where investors, rather than families, are buying houses at feverish paces. In areas such as Sacramento, Los Angeles, and Phoenix (whose home prices are recovering rapidly), investors account for over a third of home purchases. In Las Vegas, investors account for a stunning 57 percent of home purchases.


Beyond this, we are still facing a foreclosure crisis. Sales of foreclosed homes and short sales (where the bank agrees to sell a house at a loss in order to avoid foreclosure) account for 36 percent of all home sales, far above pre-crisis levels.

Principal reduction — the modification of a mortgage to reduce the amount a homeowner owes — is a proven technique to help prevent costly, unnecessary foreclosures for underwater homeowners. It can save money for investors by providing homeowners with incentives to keep making their monthly mortgage payments. What’s more, principal reduction helps neighborhoods, local housing markets, and the broader economy by preventing costly foreclosures and freeing households of debt.

Now is the worst possible time to abandon an effective public policy solution that could help families, the housing market, and our economy. Continuing to engage in principal reduction — especially if more investors, such as Fannie Mae and Freddie Mac, do the same — will help cement recent gains and ensure a sustainable, lasting recovery.