5 states get mortgage help

NEW YORK (CNNMoney.com) -- Five states hit hard by the mortgage crisis will soon share $1.5 billion in federal funds to help the unemployed and the underwater who owe more than their homes are worth.

The Treasury Department on Wednesday approved proposals by Arizona, California, Florida, Michigan and Nevada. The states will use the money primarily to subsidize homeowners' monthly mortgage payments and to reduce their principal. Some of the funds will also go to paying off second liens or facilitating short sales.

"These states have identified a number of innovative programs that will make a real difference in the lives of many homeowners facing foreclosure," said Herbert Allison, an assistant Treasury secretary.

State officials said they would implement the programs in coming months. They are being administered by the housing finance agencies in each state and are expected to help up to 75,000 households.

The state proposals have caused a stir within the housing industry. Many consumer advocates say troubled homeowners should get financial help to pay off their mortgages, lest the housing crisis continue to spin out of control and drag down everyone's property values. But other housing experts warn that paying off loans creates a moral hazard and could actually dissuade people from looking for work.

Treasury officials largely signed off on the states' plans, rejecting proposals to provide assistance to homeowners fighting foreclosure in court and to give prospective homebuyers help with their downpayments.

Many of the states' plans, however, rely on matching funds from loan servicers and are still hammering out agreements with them to do this. Servicers have been loath to write off borrowers' loans.

For instance, Arizona is willing to pay as much as $50,000 of a homeowner's loan balance, if the servicer matches. The Grand Canyon State is still working out the details with financial institutions.

Florida, meanwhile, plans to cover up to nine months of a borrower's monthly mortgage payments, but has yet to sign up any servicers willing to match this subsidy. Treasury is requiring the state to pilot this program, which it will do in Lee County starting in mid- to late-August.

One of the remaining holdups are Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500), the government-controlled mortgage finance titans that don't allow principal reduction on the loans they back. State officials are continuing to negotiate with the companies and their regulator.

The federal government plans to dole out a total of $2.1 billion to 10 states, which also include North Carolina, South Carolina, Rhode Island, Ohio and Oregon. Treasury will rule on the remaining five states' plans by August.