Report Housing

Mortgage Principal Forgiveness Policy Is a Bad Idea

August 1, 2016 4 min read Download Report

John Ligon

Former Senior Policy Analyst and Research Manager

John Ligon worked on dynamic economic modeling of federal public policy as a senior policy analyst at The Heritage Foundation.

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The Federal Housing Finance Agency (FHFA) continues to pivot on mortgage principal forgiveness policy, initiating a new program that would subsidize a permanent reduction of a portion of unpaid mortgage principal owed by homeowners. The mortgage principal forgiveness program would give preference to some homeowners already in the Fannie Mae-guaranteed and Freddie Mac-guaranteed portion of the housing finance system.

Instead of implementing this new program, the FHFA should abolish any policy that expands the influence of these two enterprises in housing markets and support housing-finance reforms aimed at shutting down these government-sponsored enterprises (GSEs). Until Congress passes legislation that shuts down Fannie Mae and Freddie Mac, the FHFA should cease the implementation of its new mortgage principal forgiveness program and end the financing of any similar mortgage-relief subsidies.

The FHFA Continues to Pivot on Mortgage Principal Forgiveness Policy

The FHFA’s intervention in the housing-finance system since the conservatorship of Fannie Mae and Freddie Mac has, in large part, occurred through various mortgage relief programs extended to homeowners. The FHFA’s housing assistance efforts predominantly comprise subsidized loan alterations through the agency’s direct mortgage refinance and modifications programs, as well as those it undertakes through the Home Affordability Refinance Program (HARP) and the Home Affordable Modification Program (HAMP). The FHFA received authority under the Emergency Economic Stabilization Act of 2008 to initiate the mortgage modifications and administer loans guaranteed by the GSEs.[1]

Generally speaking, the mortgage modifications aim to reduce the payment terms on loans and involve some combination of refinancing interest rates on mortgage loans and adjustment to the length of the loan. The FHFA has recently introduced mortgage principal forgiveness options in conjunction with its ongoing modification subsidies, including a decision this year to support a new principal reduction program for homeowners determined by the agency to be in severe distress on their loans.

The FHFA forecasts that up to 33,000 homeowners could receive the principal forgiveness subsidy in the new program that targets non-performing loans at least 90 days delinquent and possessing a loan-to-value ratio equal to or greater than 115 percent.[2] Eligible homeowners would obtain the mortgage principal forgiveness on a portion of unpaid principal balance (UPB), which cannot exceed $250,000,[3] and upon maintaining three timely payments during an initial forbearance period.[4]

For example, a homeowner in the mortgage principal reduction program holding $150,000 in UPB and receiving 10 percent total principal forbearance would be required only to make interest and principal payments on $135,000 after the modification—and receive $15,000 in mortgage principal forgiveness upon qualification.[5] By government decree, then, the FHFA’s principal forgiveness program for qualified non-performing loans backed by Fannie Mae and Freddie Mac would, similar to the agency’s other subsidized loan modifications, provide certain privileged advantages to:

Qualified mortgage issuers through subsidized business lending activity,
Select homeowners benefiting from a reduction in the repayment term on their respective mortgage contracts and an improved level of home equity, and
Institutions purchasing non-performing loan pools, gaining financial advantage in their respective portfolios.

Unnecessary Government Intrusion into the Housing Finance System

The FHFA’s mortgage forgiveness program would extend to a limited population of homeowners, and any extensive economic effects would be less discernable than those occurring with any wide-ranging mortgage principal-forgiveness policy.

In fact, even under a broad mortgage principal forgiveness scenario, the Congressional Budget Office has estimated that there would likely be no boost to the economy or change in effective demand for housing.[6] If distressed homeowners do not experience any change in their employment status and permanent income, then any direct impact the subsidy program may have for homeowners would likely be temporary. Indeed, academic research has shown that mortgage holders already delinquent on loan repayment tend to have continued difficulty maintaining proper and timely repayment of the home loan after various loan failure prevention efforts.[7]

In any instance, intervening in housing markets is not the role of the federal government. The entire apparatus of home loan modifications administered through the FHFA during the conservatorship of Fannie Mae and Freddie Mac has only expanded the influence of the federal government in housing markets by pushing mortgages into the government-guaranteed portion of the housing finance system and extending advantages to those already in it. While these subsidized mortgage debt-relief programs may temporarily provide some semblance of “stability” to a homeownership experience, the overall intervention by the FHFA in the housing finance system occurs at taxpayers’ expense, favors some market participants over others, and continues to hold back a real, market-driven housing recovery.

Abolishing the FHFA’s housing-assistance programs would help create the conditions for a durable recovery in housing markets by restoring some degree of the market discipline necessary for prudent individual financial decision-making, certainly with reference to decisions related to the choice of the level of home loan debt to assume and wise investment and mortgage-lending practices among investors and financial institutions.

The FHFA Should Not Pursue Mortgage Principal Forgiveness

Federal policy that creates special treatment for some market participants over others at taxpayers’ expense is antithetical to a free-enterprise housing-finance system. The FHFA should avoid policies that create moral hazard and expand the federal government’s influence in the housing-finance system, which occurs when the agency advances policies that increase the number of mortgages backed by Fannie Mae and Freddie Mac and subsidize favored treatment to mortgages already guaranteed by the GSEs.

Until Congress passes legislation that shuts down Fannie Mae and Freddie Mac, the FHFA should cease the implementation of the new mortgage principal forgiveness program and avoid any similar mortgage-relief policy.

—John L. Ligon is Senior Policy Analyst and Research Manager in the Center for Data Analysis, of the Institute for Economic Freedom and Opportunity, at The Heritage Foundation.

[1] Federal Housing Finance Agency, “Federal Property Manager Report,” December 2008, http://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2008-12-2_FPMReport_508.pdf (accessed June 3, 2016). See also Federal Housing Finance Agency, “Foreclosure Prevention Report—Federal Property Manager’s Report—First Quarter of 2016,” http://www.fhfa.gov/AboutUs/Reports/ReportDocuments/FPR_1Q2016FINAL.pdf (accessed July 11, 2016), and Federal Housing Finance Agency, “January 2016 Refinance Report,” http://www.fhfa.gov/AboutUs/Reports/ReportDocuments/Refinance_Report_January_2016.pdf (accessed July 26, 2016).

[2] News release, “FHFA Announces Principal Reduction Modification Program and Further Enhancements to NPL Sales Requirements,” Federal Housing Finance Agency, April 14, 2016, http://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Announces-PRM-Program-and-Further-Enhancements-to-NPL-Sales-Reqts.aspx (accessed April 19, 2016). Also, while prior non-performing loan pool sales are small (generally less than 1,000 loans per pool), there is some concentration to certain states, particularly to New York, New Jersey, and Florida. Federal Housing Finance Agency, “Enterprise Non-Performing Loan Sales Report,” http://www.fhfa.gov/AboutUs/Reports/ReportDocuments/NPL-Sales-Report_May2016.pdf (accessed July 8, 2016).

[3] See Federal Housing Finance Agency, “Fact Sheet: Principal Reduction Modification Program,” http://www.fhfa.gov/Media/PublicAffairs/PublicAffairsDocuments/Principal-Reduction-Modification-Fact-Sheet.pdf (accessed June 3, 2016). See also, Fact Sheet, “Enhanced Non-Performing Loan Sale Guidelines,” Federal Housing Finance Agency, May 14, 2016, http://www.fhfa.gov/Media/PublicAffairs/PublicAffairsDocuments/NPL-Fact-Sheet_04-14-16.pdf (accessed July 11, 2016).

[4] The FHFA would cover the cost of such principal reductions, while borrowers receiving the mortgage principal reduction are responsible to cover any federal tax liability associated with the transaction. As a general note, this Heritage Foundation Issue Brief is not a comment on the federal tax treatment of such a debt forgiveness program.

[5] John Ligon, Filip Jolevski, and Norbert J. Michel, “GSE Reform: FHFA Should Not Pursue Mortgage Principal Reduction Alternatives,” Heritage Foundation Issue Brief No. 4108, December 17, 2013, http://www.heritage.org/research/reports/2013/12/home-mortgage-modification-policy-and-principal-reduction-alternatives.

[6] Congressional Budget Office, “Options for Principal Forgiveness in Mortgages Involving Fannie Mae and Freddie Mac,” May 2013, p. 22, http://www.cbo.gov/sites/default/files/cbofiles/attachments/44114_WorkingPaper-OptionsPrincipalForgivenesl.pdf (accessed November 27, 2013).

[7] We have discussed certain characteristics related to borrower behavior and the likelihood of re-default after various prevention efforts that have been studied in some of the academic literature. See Ligon, Jolevski, and Michel, “GSE Reform: FHFA Should Not Pursue Mortgage Principal Reduction Alternatives.” See also Norbert J. Michel and John Ligon, “Why Is the Federal Government Fixated on the 30-Year Fixed Rate Mortgage?” Heritage Foundation Backgrounder No. 2917, June 18, 2014, http://www.heritage.org/research/reports/2014/06/why-is-federal-housing-policy-fixated-on-30-year-fixed-rate-mortgages.