Bondi: Don’t cut homeowners’ mortgage principal

TALLAHASSEE, Fla. – May 17, 2011 – The Attorney General of Florida, a state where almost half of all mortgaged homes are underwater – opposes efforts that would force the nation’s five largest mortgage servicers to reduce the principal on loans owed by struggling U.S. homeowners.

Attorneys general in all 50 states are part of a group now negotiating a settlement with the five lenders, which are accused of falsifying and otherwise mishandling loan documents and mortgage modifications. Florida Attorney General Pam Bondi is one of seven members of the group who oppose a key negotiating point: Cut the mortgage principal for qualified homeowners.

For example, a delinquent homeowner who owes Bank of America $200,000 on a house now worth $100,000 could find the mortgage’s principal amount reduced by an as-yet-undetermined amount through the general proposal under discussion – an appealing proposal for the 2 million Floridians with such “underwater” loans.

The federal government for about a year has been pushing banks such as BOA and Wells Fargo to reduce the mortgage principal for qualified borrowers in danger of foreclosure. But nearly all mortgage modifications still involve only interest-rate reductions or extensions of the loans’ terms – for example, converting a 30-year mortgage to a 40-year mortgage.

Bondi and several attorneys general from other states say principal reduction oversteps the mission of the group that is negotiating with the five banks, and she fears it could turn into a free-for-all of underwater homeowners. The Mortgage Foreclosure Multistate Group should stick to addressing the wrongdoings of loan servicers, she said, instead of trying to dictate how lenders modify problem home loans.

Pushing lenders to forgive part of their mortgage holders’ debt could encourage even responsible homeowners to stop making payments on their loans, in the hope they can eventually get their bank to erase part of their mortgage, Bondi wrote in a recent letter to the head of the working group.

“Some homeowners may simply default on their loan and use the States’ agreement to obtain a principal reduction – whether or not they actually made an effort to maintain their mortgage,” wrote Bondi, who serves on the negotiating group’s executive board.

She called it a potential “moral hazard” that “rewards those who simply choose not to pay their mortgage – because they can simply take advantage of lenders’ obligation to honor virtually automatic principal write-downs.”

A spokesman for the head of the Mortgage Foreclosure Multistate Group said no one wants to push the easy button for everyone who is underwater on their mortgage, allowing them to skip out on their obligation. The group instead wants to find a way for families to stay in their homes, if possible, in addition to settling the complaints of fraudulent loan documents, said Geoff Greenwood, spokesman for Iowa Attorney General Tom Miller, who leads the national group.

“I don’t think the intent was ever an across-the-board reduction, but instead it was to find a meaningful structure that would realistically keep some people in their homes who otherwise wouldn’t be able to stay,” he said. “We want to establish this in a way so that people can’t game the system.”

Bondi came to her position on mortgage reductions as the chief legal officer of a state in which 47 percent of all mortgaged homes are worth less than their loan amounts, according to a fourth-quarter report by the analytics company CoreLogic. Only Nevada and Arizona have higher rates.

In the Conway section of southeast Orlando, Dan Dillard’s pool has turned a greenish hue. The button on his doorbell is missing. He has rented rooms to adult students from Korea, Saudi Arabia and Peru to help him cover a mortgage that has been a challenge since his 2008 divorce. Two previous mortgage modifications lengthened the loan term but kept his payments at $1,646 a month to recoup back taxes and other debt. Now he faces foreclosure.

The information manager for Wycliffe Bible Translators says he would like to stay in the shaded home with his two teenage children who still live there. But he figures the only way he could realistically keep his house is if his lender, Orlando Federal Credit Union, shaved $35,000 off his the $250,000 principal he owes. He estimates the home might be worth $170,000.

“It is absolutely better for any financial institution to run the numbers and modify, even if that means cutting the principal,” Dillard said. “At the end of the day, a modification gives them more money than all losses they will encounter through foreclosure.”

Cutting loan principal is the method least-used by lenders to modify mortgages. Lenders prefer to cut interest rates or stretch out the payments instead. Of more than 17,000 mortgages modified in Florida during the fourth quarter of last year, only 4 percent got a new mortgage payment based at least in part on a reduction in the loan’s principal, according to the U.S. Office of Thrift Supervision. About 90 percent had reduced or frozen interest rates, while 60 percent had longer loan terms.

Bondi wants no part of dictating to lenders how they retool their troubled mortgages. She said any such intervention could actually imperil homeowners because they could be at risk of defaulting yet again under the new mortgage terms. She cited concerns that they could end up with more debt, depleted savings and worsened credit scores if they couldn’t pay their modified mortgages.

Principal reductions, however, are viewed by some industry experts as the best tool to repair mortgages in a way that homeowners can then manage.

Securitization research by Deutsche Bank last year showed that mortgage modifications with principal reductions had a redefault rate of about 40 percent after three years, compared with a rate of about 57 percent for mortgages modified with lower interest and longer terms only.

Dillard made the last payment on his Conway home of eight years in November. He said he also finds it hard to justify spending money on a house that he’s likely to lose. The credit union will end up getting back a property that needs repairs and maintenance. By the time it settles the lawyers’ fees and court costs, makes the necessary repairs, pays the property taxes and markets the house, it will lose far more than, say, a $35,000 reduction in principal, Dillard said.

The single dad, who has no other debt, is exploring bankruptcy because he doesn’t want to pay what could be the $80,000 balance on his mortgage after the house sells. He is concerned about his credit but said he and his children will be fine.

“Orlando loses. My neighborhood loses. I don’t lose – I’m a Christian man, and I’m trying to do the right thing,” Dillard said. “At the end of the day, we will be OK.”