Obama expands mortgage modification effort

NEW YORK (CNNMoney.com) -- Under fire to do more to stop the foreclosure crisis, the Obama administration announced new mortgage modification steps on Friday to help the unemployed and those who are "underwater" with a bigger loan than their home is worth.

The centerpiece of the expanded program addresses the steep decline in property values by requiring banks to consider reducing loan balances, a move a growing chorus of experts say is essential to righting the housing market. Banks, however, have been very reluctant.

Also, lenders will now be required to temporarily reduce -- or even suspend -- payments for eligible unemployed borrowers. The forbearance assistance would last up to six months, after which the borrower would be evaluated for a loan modification.

"All the programs are really trying to facilitate what should be happening in the marketplace anyway," said Diana Farrell, a White House economic adviser, in a press conference. "It's actually in the interest of lenders to reduce the loan balance because those will be sustainable, higher quality loans. Similarly, it's in the interest of borrowers to get into a loan that they can actually afford and sustain over time."

The expansion of the president's signature $75 billion loan modification program will begin in the fall and be paid for with money from the Troubled Asset Relief Program.

Principal reduction: The new initiative encourages servicers to reduce loan principal for delinquent borrowers when that is more advantageous to mortgage investors than reducing interest rates.

While lowering balances would remain optional, many servicers are required by contract to do what is in the investor's best financial interest. Servicers and second-lien holders would receive financial incentives to write down principal.

Principal reduction would be available for HAMP-eligible borrowers who owe more than 115% of their home's current value. The balance would be forgiven as long as the homeowner makes timely payments for three years.

FHA refinance: Some borrowers who are current on their mortgages but have seen their property values drop could refinance into Federal Housing Administration loans worth no more than 97.75% of their home's price. If the borrower has a second lien, the total mortgage debt could not exceed 115% of the property's value.

Homeowners, however, must meet FHA's qualifications and have a credit score of at least 500. Their new monthly payments would be no more than 31% of their monthly income.

Some $14 billion has set aside to provide incentives to encourage servicers and second lien holders to participate in the FHA program.

The unemployed: Servicers would be required to offer forbearance plans to all qualified jobless borrowers for at least three and as long as six months. Under the plan, the unemployed could see their monthly payments reduced to 31% of income or less -- or even suspended entirely.

Borrowers must meet HAMP eligibility requirements as well as submit evidence that they are receiving unemployment benefits. They must also be in their first 90 days of delinquency.

After the assistance period ends, homeowners would be evaluated for a loan modification or foreclosure alternatives, such as short sales, in which a bank agrees to sell the property for less than what is owed.

An administration official declined to comment whether interest or fees would be charged during the forbearance period.

Separately, the government will double the incentive to servicers to complete a HAMP modification, to $2,000, and provide more funds to second-lien holders that release borrowers from their debt. It will also double relocation assistance to borrowers who cannot afford to stay in their homes to $3,000.

By adding these measures, the administration's loan modification program could help 1 million to 1.5 million borrowers avoid foreclosure, according to preliminary calculations by Mark Zandi, chief economist with Moody's Economy.com. Previously, he estimated the plan would only help 500,000 keep their homes.

Nearly one in four borrowers in America are underwater, according to First American CoreLogic. Many experts have said the only way to stem the foreclosure tide is to reduce the loan balances of these borrowers, who are more likely to walk away.

The expansion announced Friday will help convince people to stay in their homes, said Marietta Rodriguez, director of the national homeownership program for NeighborWorks America.

"For many borrowers, it's really hard to justify figuring out a payment plan for a property that's so underwater," she said.

While banks have steadfastly avoided reducing mortgage principal, Bank of America has taken the first tentative step to cutting balances. It announced Wednesday it would lower the mortgage principal of a limited number of borrowers if they remained current for five years.

The new Obama administration initiative follows a smaller effort announced last month that would provide $1.5 billion to housing finance agencies in five states to develop programs to assist the unemployed and underwater.

Reducing loan balances, however, is very controversial. Some experts fear the benefit will go to those who don't truly need or deserve it, the so-called "moral hazard" argument. And it's likely to anger those who continue to make timely mortgage payments every month.

The expansion of the president's loan modification effort comes on the heels of two blistering government watchdog reports, which slammed the administration for poor implementation of the program, and raised doubts that it would reach the initial goal of helping 3 to 4 million troubled borrowers stay in their homes.

The program, which calls for reducing borrowers' monthly payments to 31% of their pre-tax income, has led to only about 170,000 long-term modifications so far.

The low figure has prompted consumer advocates and industry experts to call the program -- which focuses on adjusting interest rates and loan terms to bring monthly payments to affordable levels -- a failure.

Meanwhile, the nation is sinking deeper into the mortgage crisis. The share of seriously delinquent loans in the fourth quarter jumped 21% over the previous quarter, regulators said Thursday.