Research supports key Obama housing plan provisions
HUD Secretary Shaun Donovan visited North Carolina today to detail the Obama administration's new plan to help the economy by helping responsible homeowners.
Research conducted by the UNC Center for Community Capital finds that the plan's core element – reducing homeowners' mortgage burden – is an effective strategy to reduce foreclosures and stabilize home values.
"Giving more homeowners a fair chance to refinance at today's low rates, regardless of who holds their note or services their mortgage, will provide an economic boost to families," center Director Roberto G. Quercia said.
"Targeted use of principal reduction will let lenders share the burden resulting from years of reckless lending. As important, research shows these steps will also help prevent foreclosures," he said.
Foreclosures continue to stall economic recovery
In the wake of the financial crisis, 3.4 million borrowers (nearly 8 percent of all mortgages) are currently 90 days or more late on their mortgage payments or are in foreclosure.
Nationally, a glut of foreclosed properties that are on the market is exacerbating the fall in house values, leaving an estimated 10.7 million homeowners, roughly 22 percent of all mortgages, "underwater" (meaning they owe more on their mortgage than their property is worth).
In North Carolina, house prices have fallen 9 percent from their peak. Today, Secretary Donovan said nearly 200,000 N.C. homeowners are underwater, and the vast majority are still making their payments but can't refinance. Moreover, house prices show no signs of recovering, continuing to post year-over-year declines. This overhang of debt is an albatross around the neck of the economy.
Since the scope of the housing crisis became evident, efforts both private and public have been undertaken to help struggling homeowners, but have failed to reach many key groups of borrowers.
According to the administration's announcement, the president's plan aims to "provide borrowers who are current on their payments with an opportunity to refinance and take advantage of historically low interest rates, cutting through the red tape that prevents these borrowers from saving hundreds of dollars a month and thousands of dollars a year."
Broad evidence supports plan's proposals
Research clearly supports key provisions of the plan. Among them:
Loan modifications with reduced payments and principal reduction have the lowest re-default rates. Center research shows that the combination of principal write down and rate reduction results in the highest mortgage repayment rates compared to other types of modifications. Similarly, research from the Federal Reserve Bank of New York proposes a combination of principal and interest-rate reductions that it estimates would "lower first year re-default risk by 40 percentage points – nearly four times the impact from the interest rate only strategy" now commonly pursued.
Principal reductions can result in the best net-present-value outcome. Center research shows that principal reduction modifications, though they require the investor to give up a portion of possible future principal payments – can often result in a higher net present value than rate reduction modifications because they avert more costly foreclosures. For instance, research on modifications made in hard-hit areas of the country that lowered a borrower's payment from 50 percent to 31 percent through a rate reduction posted success rates of only 40 percent, while those that used principal modifications had success rates of 58 percent. In such markets, when even greater payment reductions are needed, the research shows that using principal reduction in combination with rate reduction has the highest resulting net present value. The Federal Housing Finance Agency estimates that reducing the unpaid principal of all underwater borrowers in Fannie Mae and Freddie Mac's portfolio to 115 percent of their property's value would save more than $20 billion compared to not doing anything.
Huge variability exists across servicers. Soon-to-be-published center research shows that servicers play a significant role in both the likelihood that loan modifications will be made as well as their outcome, and that practices differ by both the size of the servicers and the location of the subject property. Compared with small servicers, most large servicers are significantly more likely to engage in loan modifications. However, research finds great variability among large servicers, with some 436 percent more likely and some 60 percent less likely to modify a troubled loan than a smaller servicer. In addition, servicers are significantly more likely to modify troubled loans in some states than others and less likely to modify loans in the neighborhoods hardest hit by foreclosures. These findings are consistent with research from the Federal Reserve Bank of Chicago, which notes, "servicer fixed effects explain at least as much variation in modification terms as do borrower characteristics."
Principal reduction and servicing standards are key to market recovery
Despite evidence that supports principal reduction as a key recovery strategy, the latest Mortgage Metrics Report released by the Office of Thrift Supervision and Office of the Comptroller of the Currency shows less than 8 percent of loan modifications in the third quarter of 2011 reduced principal. Meanwhile, more than 88 percent added (or capitalized) past due amounts to the loan, increasing the remaining balance. In fact, more than 97 percent of loans modified by Fannie Mae and Freddie Mac added to the unpaid principal in this way and none were modified to reduce mortgage debt.
Overall, the center's research shows the importance of tailoring loan modifications to the particulars of individual borrowers with specific loan products in specific housing markets.
There is evidence that payment relief resulting from rate reduction (or term extension) exclusively does work, but it is not the best approach in all situations.
In many instances, principal reduction modifications result in the lowest re-default rates and highest net present values.
Encouraging servicers to implement such modifications will provide needed stability to the market as will consistent implementation of loan modifications by servicers. The administration's new plan incorporates both of these key components.
A Capital Idea is published by the UNC Center for Community Capital as a resource for policymakers, advocates and private-sector partners interested in finding sustainable ways to expand economic opportunity to more people, more effectively.
The Center for Community Capital, based in the College of Arts and Sciences at The University of North Carolina at Chapel Hill, is the leading center for research and policy analysis on the transformative power of capital on households and communities in the United States.
UNC Center for Community Capital