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Principal reductions are few and far between

March 28, 2012: 2:34 PM ET
Foreclosed home

Not many troubled homeowners get principal reduction.

Mortgage servicers will have a lot of work to do to prepare for the coming wave of principal reductions unleashed by the $26 billion mortgage settlement.

That's because they haven't been doing many of them up until this point.

Only 8.5% of loan modifications in the fourth quarter of 2011 involved principal reduction, according to the latest government data. That's a mere 9,867 troubled homeowners for the quarter.

While that's up more than 200% from the year earlier, it's still a pittance. More than three-quarters of loan mods involve rate reductions and more than half extend the terms, according to the Office of the Comptroller of the Currency.

All of last year, only 35,200 borrowers, or just over 6%,  received principal reduction as part of their modification.

Since Freddie Mac and Fannie Mae don't allow principal reductions, these lucky homeowners all had mortgages owned by banks or private investors. In the fourth quarter of 2011, banks used principal reduction in one-quarter of the modifications on loans they owned and in 16.4% of mortgages held by private investors.

Under the mortgage settlement, announced in mid-February, up to 1 million homeowners could have their principal reduced by an average $20,000. Some $17 billion is going toward lowering the mortgage balances on homeowners whose properties are worth less than what they owe.

Once again, homeowners with loans held by Fannie and Freddie are being left out in the cold. Only borrowers whose mortgages are held by five major lenders are eligible.

While the Obama administration has largely focused on making monthly mortgage payments affordable by lowering interest rates and extending loan terms, many experts say principal reduction is the key to stabilizing the housing market. Some 11 million people, or 22.8% of borrowers, owe more than their home is worth.

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