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 GSEs & Principal Reduction: How HAMP Helps More Underwater Homeowners

By: Michael Stegman

​Recently, various sources have alleged that large banks will get a windfall if Fannie Mae and Freddie Mac (the GSEs) reduce the principal balance on first lien mortgage loans that are owned or guaranteed by the GSEs.  The claims arise from a concern that if the GSEs reduce the principal balance on a GSE first lien mortgage loan, any investor holding a second (and subordinated) lien on the property stands to benefit unfairly.

In fact, the principal reduction program that we have asked the FHFA to allow the GSEs to participate in, the principal reduction alternative of the Home Affordable Modification Program (HAMP), is designed to protect against exactly this result.

Of course, not all under water GSE loans have second liens. But if they do, under HAMP, where a first lien mortgage is modified, then the holder of an eligible second lien must modify that lien proportionately if they are a participant in the Second Lien Modification Program (2MP).  Most major servicers are participants in 2MP, so most will be obligated. Thus, any HAMP modification that includes principal reduction would trigger an obligation on the part of a participating second lien holder to write an eligible second down to the same degree. It is also worth noting that Treasury-paid incentives to first lien holders apply to matched second liens, though those incentives are less than the ones for first lien modifications, in light of their subordinated status.

So quite contrary to providing a windfall to the banks, GSE participation in this program would force them to help homeowners even further by writing down these  second lien loans.

In addition to clarifying this misconception, though, it is important to take a step back and appreciate the broader impact that GSE participation in this program would have. It would be an important tool in helping put deeply underwater homeowners back on a more sustainable path with their mortgage, lowering the chances that they have to hand in the keys and walk away from their homes.  Moreover, it will help stabilize communities and minimize losses to the GSEs and the taxpayer. As Secretary Geithner has said, principal reduction is by no means the solution for all borrowers struggling to pay their bills, or even all who struggle with negative equity. But it is smart economic policy for some, and where it is we should provide that help.

Michael Stegman is Counselor to the Secretary of the Treasury for Housing Finance Policy. 

Posted in:  Making Home Affordable, Housing Finance Reform
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