Study: Mortgage-Debt Forgiveness Is Most Effective Step For Reducing Foreclosures

A bipartisan group of lawmakers this month introduced legislation that would allow the two government mortgage agencies to take drastic action to help struggling homeowners. The legislation would mandate principal reduction programs at Fannie Mae and Freddie Mac, allowing the agencies to follow in the footsteps of other countries that have used debt forgiveness to alleviate the pain of the housing crisis.

Edward DeMarco, the head of the Federal Housing Finance Agency, has been an ardent opponent of principal reduction but has been considering a proposal that would allow Fannie and Freddie to reduce debt on the mortgages it owns. Though DeMarco has yet to make a formal decision, a new study from Amherst Securities Group found that principal reduction is the most effective way of keeping homeowners from entering foreclosure, CNN Money reports:

Only 12% of borrowers who received principal reductions re-defaulted in 2011, Amherst found. That’s compared with 23% of borrowers who received mortgage modifications with interest rate reductions (but no principal reduction) and 30% who received forbearance, which postpones their debt repayment.

“[Modifications] with principal forgiveness are apt to be most effective, as the borrower no longer owes the money — so he is no longer hopelessly underwater,” said Laurie Goodman, Amherst’s housing market analyst and one of the authors of the report.

Principal reductions have accounted for 40 percent of the modifications done by banks in 2012, but with a few small exceptions, Fannie and Freddie will not authorize principal reductions on their loans.


The Amherst report is more evidence that principal reduction is good for homeowners and mortgage servicers, as Center for American Progress policy analyst John Griffith argued in March.

“Fewer foreclosures help more than just struggling homeowners. Local housing markets are better off, as each foreclosure decreases the value of every other home in the neighborhood,” Griffith wrote. “And since the average foreclosure costs more than $50,000 to the lender or investor, avoiding default often helps the books of Fannie and Freddie, which in turn benefits every taxpayer on the hook for their losses. So while principal reduction will give more struggling homeowners a fighting chance at staying in their homes, this is not a matter of charity. It’s good business.”