Fannie Mae and Freddie Mac will let some borrowers who kept up payments as their homes lost value erase their debts by giving up the properties, helping Americans escape underwater loans while adding to losses at the mortgage giants that were bailed out with $190 billion of taxpayer money.
Nondelinquent borrowers with illness, job changes or other reasons they need to move will become eligible in March to apply for a so-called deed-in-lieu transaction that erases the shortfall between a property's value and what is owed on its mortgage. It follows a change in November that lets on-time borrowers sell properties for less than they owe, known as short sales, wiping out the remaining mortgage debt. Normally, the lenders could pursue people to recoup their losses.
"It's an extraordinarily generous approach for companies still in debt to American taxpayers," said Phillip Swagel, a professor at the University of Maryland's School of Public Policy in College Park. "We're giving people an incentive to walk away, right when the housing market is starting to right itself."
Previous foreclosure-prevention programs were designed to help only borrowers on the verge of losing their homes, in effect penalizing those who kept paying, according to homeowner advocates such as Julia Gordon, director of housing finance and policy at the Center for American Progress in Washington. In some cases, servicers have advised borrowers to stop making their mortgage payments to qualify for help, leading to evictions if their applications are denied, Gordon said.
U.S. residential real estate lost about a third of its value after home prices peaked in 2006. The collapse of the mortgage market in 2008 sparked a global financial meltdown and created the worst foreclosure crisis since the Great Depression.
There are about 7 million underwater properties, worth less than the mortgages on them, down from 11 million in 2011, according to JPMorgan Chase. Within two years, the number of upside-down home loans could drop to 4 million, the New York bank said.
"Fannie and Freddie are playing catchup, making these changes when defaults are falling and the housing market is coming back, to some extent," said Kurt Eggert, a professor at Chapman University School of Law in Orange, Calif. "It should have happened a long time ago."
The deed-in-lieu transactions, which require homeowners to leave properties in good condition, preserve the value of homes by preventing owners from abandoning them to take a new job or cope with an illness, Gordon said. Vacant and dilapidated real estate drags down values of nearby houses, increases expenses for Fannie Mae and Freddie Mac, and reduces the amount they'll recover when the property is sold, she said.
"Fannie and Freddie are finally recognizing that some people are stuck in their homes," she said. "There are a lot of families who need to move who can't do it if they're going to have debt hanging over their heads. There's no winner when someone is forced to default on their mortgage — not the investor, not the homeowner and certainly not the neighborhood."
For either a deed-in-lieu or a short sale, the failure to pay off the full mortgage balance will be reported to credit bureaus even as the amount is forgiven. The effect on scores will be nearly as bad as that for foreclosures, according to Fair Isaac Corp. However, if borrowers keep current with their payments during the process, they won't take additional hits for delinquencies.