New data on the Home Affordable Modification Program (HAMP) from May 2012 show that a growing number of loan modifications are reducing principal on the loans outside of a program designed to incentivize principal reductions. The U.S. Department of the Treasury attributes the growth of principal reductions on loans not participating in the Principal Reduction Alternative (PRA), which provides extra incentives for writing down loan balances, to a settlement reached by U.S. Attorneys General and the five largest servicers on improper preparation of foreclosure documents.

Principal reductions have been a missing piece of the puzzle of recovering from the foreclosure crisis, but servicers are writing down principal more often on loans that are eligible for them (loans backed by Fannie Mae and Freddie Mac are not eligible for principal reductions). Part of the reason for the increase in principal reductions has to do with the terms of the settlement reached in February 2012 between Attorneys General and servicers on robosigning practices, which requires servicers to provide $17 billion of principal reductions for underwater homeowners. In this month’s HAMP report, Treasury began tracking loan modifications that include principal reductions but do not receive incentives through PRA. Treasury attributes the growth of non-PRA principal writedowns to the robosigning settlement since servicers cannot use PRA loans to meet their settlement requirements. Of all permanent HAMP modifications including principal reductions, 23 percent occurred outside of PRA.

Another reason for the increase in principal reductions is that they simply work to prevent foreclosures. Underwater homeowners are more likely to enter foreclosure than are homeowners with equity. Research shows that underwater homeowners who receive loan modifications with principal reductions are much less likely to default again than are homeowners without principal reductions. It seems that, when it comes to loans that servicers already own, servicers recognize the value of principal reductions in certain situations. In the fourth quarter of 2011, even before the robosigning settlement, servicers wrote down principal on one in four of the loan modifications they hold in portfolio. That figure rose slightly to 29 percent in the first quarter of 2012.

Edward DeMarco, the acting director of the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, has yet to issue a decision on whether FHFA will allow Fannie Mae- and Freddie Mac-backed loans to be eligible for principal reductions. In January 2012, Treasury offered extra incentives to FHFA to participate in PRA. Modifications of Fannie Mae and Freddie Mac mortgages comprised more than 40 percent of all modifications in the first quarter of 2012, meaning that many underwater homeowners were not eligible for this type of effective relief. We have long urged DeMarco to allow principal reductions or make room for a leader who will. The Government Accountability Office released a report this month urging FHFA to “expeditiously finalize its analysis” as well.

Loan modifications within PRA (which do not count toward the robosigning settlement) continue to see a relatively steady number of trial modifications and moderate growth in permanent modifications (see Fig. 1). Trial PRA modifications dropped by 8 percent from 16,986 in April to 15,591 in May, while permanent modifications grew by 6 percent from 54,760 in April to 57,786 in May.

Overall HAMP modifications continued their slow pace of growth in the Chicago region and nationwide. Total HAMP modifications in the Chicago area grew by 0.8 percent from 44,521 in April to 44,882 in May, marking one year of month-to-month growth less than two percent. National HAMP figures marked the same milestone with growth of 1 percent from April (873,950 active modifications) to May (882,706 active modifications).

Additionally, an expansion of HAMP which makes eligible owners of occupied and unoccupied rental property and homeowners facing hardship with housing costs below 31 percent of their income took effect  on June 1, though some of the largest servicers do not expect to have it implemented until the fall.

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