Is Bank of America headed towards principal reductions?
Reader Paul (big hat tip to him) pulled a key comment out of the B of A press release issued earlier this week that addressed Bank of America’s efforts to help homeowners keep their home. The comment, burried at the bottom of the release was:
“We will continue to work with distressed borrowers to match the customer’s repayment ability with the appropriate loss mitigation option, including loan modifications, forbearances, repayment plans, lower rates and principal reductions,” McGee said. “
Paul thought it was absurd that no one pressed McGee on the last point which was “principal reductions.” This, he argued correctly, is a massive change in policy for the industry, as banks have been fighting tooth and nail to make sure that court-ordered principal reductions (cram downs) aren’t enforced from the bench.
The Implications of a BofA-led Principal Reduction Effort Would be Staggering
If Bank of America is truly making principal reductions a part of it’s “home-saving” playbook it would have incredibly wide-spread implications across not only the banking industry but the housing market and general economy.
As Paul mentioned, the press didn’t have a chance to grill him on this point and I agree with him that McGee needs to be held accountable for what he said and to outline in greater detail just what role these principal reductions are playing (or will play) in BofA’s loan modification process.
Bank of America, if they are making principal reductions even a trivial part of their options in keeping homeowners put they will set a precedent which will inexorably alter the housing market. Think of the ramifications of this action.
First of all, Bank of America’s adoption of this policy would make it essentially an industry-accepted practice overnight. Lenders of all types would gladly follow their lead in an effort to keep their REO rolls from growing exponentially. Why wouldn’t a lender take a $25,000 principal reduction if it keeps the mortgage current than risk the pain and headache of foreclosing for a property that might only sell for 50% of the current note?
The Ultimate Moral Hazard
Homeowners who are struggling with their payments due to myriad reasons (from fraudulently overstating their income to a resetting option-arm to death of the primary wage earner) will see principal reductions to keep them in their home. The homeowner next door in a comparable home will not see that relief as long as they continue to make their payments on time.
Homeowners are rewarded for feigning problems with their mortgage payments to get the reduction. It’s a less-painful version of mailing in your keys. Go down 60-days on your mortgage and get a nice chunk of your loan balance forgiven.
A Good Homeowner Gamble?
The argument that the mere idea of a damaged credit score is enough to keep full-balance folks paying right along while their neighbors get gifted $50k loses credibility in the current environment. If I’m a homeowner (which I am) and I’m current on my mortgage (yes, again) and I’m seeing all of the bail out plans and changes being made and I see Bank of America add principal reductions to their loan modification tool kit for delinquent borrowers I might start to think that there is going to be some government intervention on future credit as a result of this mess too.
Think about it - with all of the changes to save homeowners who are losing their homes and going down late on their mortgages the government will surely want to address future credit opportunities for those bailed-out. They may even be thinking of a way to help folks who suffered a foreclosure or late payments by a “resetting ARM” be distinguished in credit scoring from those who faced bankruptcy or late payments on consumer debt.
If I’m a homeowner who is seeing principal reduction around them I might trade $50,000 in debt forgiveness for a couple of years of higher interest-rate costs. Heck a back-of-the-envelope calculation might show that it’s worth it even without changes to current credit scoring methods and the laws governing same.
Is Once Enough?
Do you only get one shot at the reduction? Blown Mortgage regular Ann had this to say about the principal reduction path:
The question I have is what types of loans are going to be modified? Teaser ARMS? MTA’s? Also how do you modify? Based on True income when it was a liar loan? Principal Reductions in a declining market..does that mean that a year from now when the price goes down another 10% are those borrowers going to expect more? What about the average Joe next door, who isn’t a “troubled” borrower and now has a principal balance of $300K..while his neighbor had 50K forgiven and now has principal balance of $250K?
Seems to me there is no end in sight…
And that’s another major challenge. What happens to the neighbor who takes the write-down now, and then sees his neighbor take a write-down in six-months that is double the amount forgiven to him? Does that neighbor sue Bank of America for an additional reduction?
Where do Second Mortgages Fit In?
The questions keep going. What about second mortgages? Where do those fit in? Does Bank of America forgive debt on the second first or keep the higher-rate (mostly unsecured) second debt and reduce the principal on the first? How does that get figured out.
What did McGee Mean?
In the end Paul is right - what is Bank of America really considering with these loan modifications and principal reductions as they mentioned in their sweeping press release about homeownership. Did they “misspeak”? Were they only pointing to the options available in the entire universe of home-saving? It’s a question that needs to be drilled down on and Bank of America needs to be held accountable to what they said for the sake of all participants in this market.
What do you think?