Table of Contents
We’ll define principal reduction and go over its history in this section. Since principal reduction programs are no longer available, we’ll discuss other options if you have negative equity or are having trouble paying your mortgage.
Many homeowners have financial difficulties and find themselves unable to pay their mortgage.
For homeowners with negative equity (owing more on their home than it is worth), principal reductions were a possibility.
What Was the Purpose of Principal Reduction?
Principle reductions were offered to homeowners with underwater mortgages (also known as negative equity) in the aftermath of the subprime mortgage crisis.
They reduced the principal sum payable on the mortgage. Principal reductions were created to assist both the borrower and the lender in avoiding foreclosure.
A principal decrease could be used instead of foreclosure. A foreclosure benefits no one.
Following the significant influx of people defaulting on their loans after 2009, schemes to lower the principle owed were implemented to keep homes out of foreclosure.
The Subprime Mortgage Crisis and Principal Reductions
Principal reductions resulted from the 2008-2009 financial crisis, which was exacerbated by the subprime mortgage housing bubble.
Because they were granted to individuals with low credit scores, these mortgages were dubbed “subprime.” As a result, many people found themselves in debt for homes they couldn’t afford.
The real estate bubble broke when consumers began to default on their mortgages.
As housing values fell, many people found themselves with negative equity.
The US government responded by establishing the Home Affordable Modification Program (HAMP), as well as other major reduction programs.
Principal Reduction Programs
Let’s take a look at some of the principal reduction schemes that have aided homeowners who are having trouble paying their mortgage.
These programs were implemented in the aftermath of the housing market meltdown and have since run their course.
Home Affordable Modification Program (HAMP)
HAMP was a federal loan modification program introduced in 2008 in response to the subprime mortgage crisis as part of the Troubled Asset Relief Program of the United States government (TARP).
In the second quarter of 2009, Fannie Mae and Freddie Mac joined together to execute HAMP.
Among the prerequisites for HAMP eligibility were:
➣ Mortgages with an unpaid balance of less than $729,750 were required.
➣ Property could not be declared uninhabitable or condemned.
➣ The debt-to-income ratio (DTI) must meet certain criteria to indicate financial distress.
HAMP was terminated in 2016.
Hardest Hit Fund (HHF)
HHF was established by the US Treasury in 2010. It was created to help states that were hardest hit by the subprime mortgage crisis. 18 states and the District of Columbia were eligible for the HHF.
Many states, such as Keep Your Home California and Step Forward Michigan, used this financing to build their own initiatives.
Each state had its own eligibility conditions, with the common requirement that the domicile be the primary residence in the state where the program was located.
When HAMP expired in 2016, Congress extended money to HHF, extending it through 2020.
Principal Reduction Modification
The Federal Housing Finance Agency (FHFA) introduced the Principal Reduction Modification program in 2016.
It was a one-time initiative. Borrowers had to be at least 90 days late and have an outstanding principal balance of $250,000 or less to qualify, among other requirements.
Borrowers with Fannie Mae or Freddie Mac loans were the only ones eligible for the program. It was completed in October of 2016.
Eligibility for Mortgage Principal Reduction
Although principal reduction programs are no longer available, general mortgage payment assistance may be available. In general, your property must be distressed or in danger of foreclosure to be qualified.
Most of these programs have limits on how much you can owe in principal and require that the property be your primary residence.
If a principal reduction is an option, you must be able to demonstrate that you will be able to afford your mortgage payments after the decrease.
Opportunities for principal reduction have become scarcer with the conclusion of HAMP and the principal reduction adjustment in 2016, as well as the HHF in 2020. So, let’s look at some options.
Alternative Solutions for Negative Equity Homeowners
Here are some alternative possibilities if you’re battling with negative equity and aren’t eligible for or can’t find a principal reduction program:
➣ Increase your equity. Staying in your house and creating equity via regular payments is an option if you’re employed but your mortgage is underwater due to a decline in the housing market. Your negative equity could be fixed if you can wait for the market to recover.
➣ Refinance your mortgage to get a cheaper monthly payment. A home loan refinance with a lower rate and shorter term could help you lower your monthly payment. If you can refinance to a lower rate, you may be able to save money both monthly and over the life of the loan.
➣ Ask about getting your loan modified. A loan modification is a change to your mortgage’s original terms and structure.
While a loan modification may appear to be the same as a refinance, the differences are that you must apply for one with your lender, you do not pay for it, and it may have a negative impact on your credit score.
➣ Loan forgiveness. If you’re having difficulties paying your mortgage, your lender may grant you loan forbearance. Loan forbearance suspends payments temporarily owing to a temporary financial problem. To determine if you qualify, contact your lender.
FAQs about Principal Reduction Modification
1.What Is Fannie Mae and Freddie Mac’s (the Enterprises) New Principal Reduction Modification Program?
The Enterprises are conducting a principal reduction modification program for those seriously delinquent, underwater homeowners whose loans are owned or insured by Fannie Mae or Freddie Mac, at the direction of the Federal Housing Finance Agency (FHFA).
Eligible borrowers will be able to get a loan modification that will forgive a portion of their mortgage debt permanently.
This final crisis-era modification program is a last-ditch effort to keep chronically delinquent, underwater homeowners out of foreclosure, as well as a targeted effort to assist stabilize areas that have yet to recover from the financial crisis.
To guarantee that this program benefits both underwater borrowers and the Enterprises, the Enterprises are establishing a variety of program features and qualifying requirements.
2. Who Is Eligible for a Principal Reduction Modification?
Enterprise borrowers who owe $250,000 or less on their unpaid principal balance and were at least 90 days late on their mortgage as of March 1, 2016, are eligible for the Principal Reduction Modification.
Only owner-occupied properties (main residences or second houses) are eligible; the loan cannot have been used to buy an investment property.
At the time the borrower is reviewed for the modification, the amount outstanding on the first lien mortgage, including any unpaid principal, interest, taxes, insurance, or other arrearages, must be greater than or equal to 115 percent of the home’s value.
The principle reduction program is not available to borrowers who are currently on a loan modification trial period plan with a first payment due date before May 1, 2016.
The Enterprises’ Streamlined Modification program’s eligibility criteria are generally followed by all other eligibility criteria.
3. When Will I Know if I Am Eligible for a Principal Reduction Modification and what to do to accept the change?
If you are qualified for a Principal Reduction Modification, your mortgage servicer (the business to whom you send your mortgage payments and who provides you loan modification choices) must contact you after the program’s introduction but no later than October 15, 2016.
Servicers have until December 31, 2016, to recruit borrowers for Principal Reduction Modifications.
Because different mortgage servicers have differing capacity for implementing the program, some eligible borrowers may hear from their servicers sooner than others.
In general, qualified borrowers must make their first trial payment within the month following their month of solicitation in order to receive a Principal Reduction Modification.
Borrowers will not be required to submit complicated data regarding their income or assets, as with the Enterprises’ successful Streamlined Modification program.
These borrowers will have earned a principal reduction modification after making three timely trial payments, meeting all conditions of the trial period plan, and signing and delivering the final modification documentation.
Borrowers who do not want their principal decreased will be able to opt out of the program’s forgiveness component.
4.What Should I Do if I Believe I Am Eligible for the Principal Reduction Modification but Do Not Want to Wait for My Servicer To Apply the Program?
Borrowers should move quickly to obtain assistance and avoid foreclosure. By July 15, 2016, servicers will have contacted all borrowers who may be eligible for the Principal Reduction Modification for a Streamlined Modification.
Before servicers have completely implemented the program, this solicitation will allow borrowers to begin the process of obtaining a principal reduction modification.
Borrowers who believe they may be qualified for a Principal Reduction Modification and would like to pursue one before their servicer implements the program should accept this Streamlined Modification offer and follow the trial period plan (all trial modifications with first payment due dates on or between May 1 and December 1, 2016, may be eligible).
Accepting a loan modification will stop the foreclosure process, but it does not mean you will be eligible for a principal decrease.
If a servicer later deems that a borrower is qualified after accepting the Streamlined Modification offer and completing the trial period plan, the permanent modification’s principal forbearance will be converted to principal forgiveness.
A solicitation for a Streamlined Modification with principal forbearance will be sent to all borrowers who are eligible for principal reduction.
Borrowers who are found to be ineligible for principal reduction will keep their current modifications.
Servicers must notify eligible borrowers with a Streamlined Modification trial period plan first payment due date on or between May 1 and December 1, 2016, of the chance to opt out of principal reduction no later than December 31, 2016.
If an eligible borrower does not opt out, a portion of the outstanding loan debt will be automatically reduced by the servicer. Borrowers who are having trouble paying their mortgages or have questions about the program can contact their servicers.
Servicers will need time to put the scheme in place and decide whether debtors are qualified.
Borrowers who are current on their mortgages or making trial period payments on an existing Enterprise modification offering should keep making payments, as no borrower who falls behind after March 1, 2016, will be eligible for the program.
5. What Does a Principal Reduction Modification Entail?
The Principal Reduction Modification is comparable to the Enterprises’ current Streamlined Modifications in that it reduces monthly mortgage payments by the same amount.
To provide Streamlined Modifications, servicers capitalize (add) outstanding arrearages (missed mortgage payments and other delinquent mortgage expenses) to the loan’s principal balance, lower the loan’s interest rate to the current market rate, extend the loan’s term to 40 years.
If a borrower is underwater, forbear principal to either 115 percent of the mark-to-market loan-to-value ratio (MTMLTV) or 30 percent of the unpaid Forbearance postpones interest-bearing payments on a portion of the outstanding principal until the end of the loan term.
While forbearance lowers a borrower’s monthly payment in the same way as forgiveness does, it does not lower a borrower’s entire debt.
The Principal Reduction Modification allows qualifying borrowers to have their principal forbearance canceled rather than deferred until the end of the loan term, as a Streamlined Modification requires.
For example, if a property is worth $150,000 but the borrower owes $200,000, the servicer would reduce the principal to 115 percent of the property’s value ($172,500).
If the borrower does not opt out of forgiveness, the $27,500 in principle forbearance will be forgiven after the permanent loan modification is closed.
6. Can I Refuse Principal Reduction if I Decide It Is Not in My Best Financial Interests?
You certainly can. If you accept a permanent Principal Reduction Modification or are eligible to have the principal forbearance in your modification converted to principal forgiveness, your servicer will send you an opt-out letter with instructions on how to refuse the principal reduction.
If you choose not to opt out, the terms of the modification will stay the same, and you will be responsible for repaying the delayed principal balance at the sooner of the sale of your property, the discharge or refinance of your mortgage, or the final maturity date.
If you choose not to participate in principle reduction, your modified monthly mortgage payment will remain unchanged.
7. How Long Will It Take for the Principal Reduction to Take Place Once the Modification Has Been Approved?
If you sign and send the loan modification agreement to your servicer and do not opt out of the program, the principal reduction will occur when the modification becomes permanent.
You must complete the trial period plan criteria, which include making all three trial period payments on time, before the loan modification becomes permanent.
Servicers will send an opt-out letter no later than December 31, 2016, to borrowers in an active Streamlined or other modification trial period plan with a first payment due date on or between May 1 and December 1, 2016, who are eligible to have principal forbearance converted to principal forgiveness.
8. Will a Principal Reduction Affect My Taxes?
It may. Borrowers who live in their homes as their principal residence and otherwise meet the requirements of the Mortgage Forgiveness Debt Relief Act may be eligible to have forgiven mortgage debt excluded from their taxable income.
The Internal Revenue Service has published instructions on how Principal Reduction Modifications are taxed (Notice 2016-72).
Regarding the tax implications of accepting a Principal Reduction Modification, all borrowers should contact a tax advisor.
9. I Am Looking for a Short Sale or Deed-in-Lieu of Foreclosure, Can I Receive the Principal Reduction Modification?
Principal Reduction Modifications are not available for loans that have been approved for a short sale or a deed-in-lieu of foreclosure.
Whether you fulfill the qualifications for the Principal Reduction Modification but don’t have an approved agreement or sale, contact your servicer to see if you qualify.
10. I’m in the Process of Foreclosure, Am I Eligible?
To find out if you are eligible, contact your servicer. Throughout the foreclosure process and up until 60 days before to a foreclosure sale date in a judicial foreclosure state or 30 days prior to a foreclosure sale date in a non-judicial foreclosure state, servicers may continue to approach borrowers for a modification.
Accepting an Enterprise loan modification (Streamlined, Principal Reduction, or other) will put an end to the foreclosure process. After a foreclosure sale, the mortgage loan is no longer active and cannot be changed.
In conclusion
As a result of the 2008 subprime mortgage crisis, principal reduction was a strategy utilized to assist homeowners who were underwater on their mortgage and having difficulty making payments. HAMP and the HHF, two key federal programs, have now expired.
While these programs are no longer available, homeowners who have negative equity or are having problems paying their mortgage still have options.
If you’re having trouble keeping up with your mortgage payments, look into ways to make them easier.