There is no shortage of programs now available in the mortgage industry to help ease the foreclosure crisis. Although some of them provide direct financial assistance to key participants in the foreclosure process to encourage them to find a less costly alternative, there is really no national effort to address one of the most stubborn factors that often leads to foreclosure and in some cases thwarts efforts to avoid it.
Many borrowers in the U.S. owe more than their house is worth, either on just their first mortgage or in combination with a second mortgage or home-equity line of credit. A First American CoreLogic study recently estimated that 23 percent of all homeowners are in a “negative equity” position, and the number is significantly higher in states such as California that saw the sharpest increases in average house prices during the boom and have since then seen the biggest downturns.
My proposal is to create a new SCUBA program that would pay off negative equity so that loan modifications or refinances can proceed. For funding, the program would tap the massive portfolio of mortgage-backed securities that the Federal Reserve has purchased since the beginning of 2009. SCUBA payoffs would not create a new lien; instead, the government would impose a prepayment penalty on the modified loan or refinance mortgage.
The Obama administration’s Home Affordable Modification Program provides a number of fairly modest cash incentives to borrowers, lenders and investors to get all sides to agree to a change in the existing loan terms. The program requires that servicers first reduce the interest rate on the loan and convert it to a safe long-term fixed-rate mortgage that gradually pays off over time. They also have the option of extending the loan term and deferring some of the principal to a balloon payment. Several experts have noted that reducing the principal amount should be one of the first steps taken in modification, rather than the last.
Consumer advocates argue that principal reduction, through the bankruptcy process if necessary, is the key to keeping many borrowers in their home and avoiding foreclosure. The banking industry has successfully blocked several attempts to give bankruptcy courts “cramdown” authority to reduce the lender’s secured interest in a borrower’s principal residence, but the debate is far from over as foreclosure rates continue to climb.
SCUBA payments would accomplish the goal of bankruptcy cramdown -- lowering the outstanding principal to an amount that the borrower can afford -- without trampling on the lender’s security in the loan. In the case of loan modification, it would simply be an unscheduled principal payment, combined with other changes in the loan terms.
SCUBA payments could also help facilitate refinance transactions that help borrowers reach more affordable payment terms. While HAMP was designed for homeowners who can’t afford their current monthly payment but otherwise have a...