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Mortgage settlement leaves most homeowners to fend for themselves

The landmark $25 billion settlement reached by the federal government, 49 states and the nation's five biggest banks will provide long-overdue relief for hundreds of thousands of homeowners who have been struggling to navigate the mortgage mess created by lenders.

The wider impact for most homeowners, along with the housing market and economy, will be much more limited.

“You’re hardly skimming the surface,” said Paul Dales, a housing economist with Capital Economics. “It could help some people a lot, individually. But in terms of the big-picture, overall economy and housing market, it’s really just a drop in the ocean of the problem.”

The settlement takes a multipronged approach to try to unravel the aftermath of a housing market collapse that resulted in more than seven million foreclosures, created a legal morass for lenders and left a red tape nightmare for millions struggling to hang onto their homes.

Some of those who lost their homes may be eligible for a small cash payment, while others who are struggling to hang on may see their monthly payments lowered substantially through reductions in interest rates or  their principal balance. So if you’re one of the lucky homeowners reached by the program, the impact could be significant.

That won’t happen right away: the details of who will be helped and how they’ll be chosen have yet to be worked out. (See: What the mortgage settlement means to you.)

Over the next 30 to 60 days, state and federal officials say they will pick an administrator to handle the logistics and a monitor to track lenders’ compliance. It will take another six to nine months identify eligible homeowners and notify them by mail. Lenders have three years to complete loan modifications. If they come up short, unearned modification credits will be converted to a cash penalty paid to the government.

State and federal officials say the settlement could eventually help as many as a million households. Roughly 750,000 borrowers who lost their homes to foreclosure between 2008 and 2011 will get a cash payment of about $2,000. 

But the vast majority of more than 11 million homeowners who owe more than their house is worth, along with six million who are in foreclosure or behind in their payments, won’t get help. That’s because the settlement applies only to loans held on the books of the five banks that agreed to settle.

Loans held by government mortgage companies Fannie Mae and Freddie Mac, which account for more than half of U.S. residential mortgages, aren’t eligible. Nor are most loans that were sold off to private investors or are held by lenders who aren’t part of the settlement. (State and federal officials are negotiating with other lenders to try to expand the reach of the program. The deal won’t be finalized until a federal court judge signs off, which settlement negotiators say they expect in a few weeks.

“While a significant step toward fixing the foreclosure crisis, this settlement was never intended or able to provide a comprehensive remedy,” said Michael Calhoun, president of the Center for Responsible Lending, an advocacy group.  “Much more work is required.”

The five big banks included in the settlement, Bank of America, JP Mortgage Chase, Ally Financial (formerly GMAC), Citigroup, and Wells Fargo, also agreed to reform the deceptive and fraudulent foreclosure practices that have already drawn a cease-and-desist order from the Federal Reserve and sanctions from the Office of the Controller of the Currency, which regulates national banks.

Those practices include the “robo-signing” of documents without proper verification and the “dual track” process of negotiating a loan modification with homeowners while simultaneously pursuing a foreclosure. It remains to be seen whether those reforms will help prevent foreclosure abuses by servicers, who have been overwhelmed by the surge in defaults since the housing market collapsed in 2006.

Under terms of the settlement, the five lenders won’t have to pay out the bulk of the $25 billion. Some $17 billion represents credits applied toward targets lenders have to modify some of the loans on their books. Some of those modifications would have happened anyway. Based on a complex formula, bankers will earn credits on a sliding scale depending on the type of modification. The least costly refinancing methods might earn a lender as little as a nickel on a dollar; the costliest would generate a dollar-for-dollar credit. 

The architects of the program say the credit system will help them “leverage” the settlement to produce as much as $32 billion worth of mortgage relief. Even if they reach that goal, that would represent less than 5 percent of the nearly $700 billion in “negative equity” inflicted on American homeowners by the housing bust.

That negative equity continues to weigh on the housing market and economy. Without widespread write-downs of underwater mortgages  (or unless homeowners simply walk away from them)  American households will continue to transfer that $700 billion of their wealth to lenders for years to come.

Last month, the Federal Reserve included principal reduction in a "white paper" of recommendations to revive the housing market. So far, the chief regulator of government-owned Fannie Mae and Freddie Mac has resisted the idea. At a Nov. 16 hearing, Federal Housing Finance Agency Acting Director Edward DeMarco said the regulator had "been through the analytics" and decided that "the use of principal reduction within the context of a loan modification is not going to be the least-cost approach for the taxpayer to allow this homeowner an opportunity to stay in their home."

The architects of Thursday’s agreement argue that it will help make loan modifications more widely available even to the majority of struggling homeowners who are not covered.

“I believe that this agreement will eventually make widespread principal reduction throughout the country commonplace,” Iowa Attorney General Tom Miller, who led the talks on behalf of the states, told reporters. “There's going to be a significant amount done right away.”

But private analysts argue that the settlement does little to motivate bankers to write down loans beyond the $17 billion in credits.

“I don’t think they’re going to learn anything from this program,” said Patrick Newport, a housing economist at HIS Global Insight. “There is a danger in principal reduction, and that is that you create an incentive for people who are current and that intend to remain current to start asking for relief. Banks don’t want to do that that because that’s a strategy for losing money.”

The other major components of the state-federal settlement include about $3 billion that will be applied to rewriting mortgages from above market rates to 5.25 percent for homeowners who can’t qualify for a refinanced loan. That’s still well above the current average rate of 3.87 percent for a 30-year fixed mortgage, according to Freddie Mac.

Another $5 billion will be set aside to fund various state and federal mortgage relief programs, including the payments to homeowners who were subject to abusive or deceptive foreclosure practices. The process for determining who is eligible has yet to be worked out.

While those checks may help some of the estimate seven million households that have lost their homes to foreclosure, it will do little to help the housing market recover, according to Newport

“That’s just transferring money from Peter to Paul,” he said. “That doesn't help the economy or the housing market.”

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