Bank of America Cutting Mortgage Principal

Home Affordable Modification Program
The federal HAMP program has had its limits, and so far has modified only "116,000 units," says Jeffrey Gundlach, CEO of Los Angeles-based registered investment advisor DoubleLine LLC, and former Chief Investment Officer of mutual fund company The TCW Group Inc. That's a drop in the bucket considering Gundlach's number of units that are not paying their mortgages–"What happens [to the] 6.5 million units that are not paying?" Some of those are undoubtedly candidates for foreclosure but are held off the foreclosure process informally as banks and regulators try to sort out what to do about the enormous number of homes underwater–worth less than what is owed on them–in the U.S. In part, the issue is first liens, or first mortgages, versus second, junior liens–second mortgages, home equity line of credit (HELOCs). Gundlach puts the dollar amount of second mortgages and home equity loans "on banks' balance sheets [at] $1 trillion."

HAMP doesn't alter the principal owed on a mortgage, and only considers the first (senior) mortgage, revising mortgage payments to 31% of income, but doesn't look at second mortgages, home equity loans, car and student loan payments, Gundlach explained in an exclusive interview with Wealth Manager on March 18. (Watch for a Podcast of that interview on WealthManagerWeb.com, soon). That makes the "average debt-to-income ratio after modification 59.7%." The result, he argues, is a "59% redefault" rate for post-HAMP modified homeowners.

Compounding the issue are banks that hold lots of the second mortgages or home equity loans on their books, who don't want to see principal amounts on these second, junior liens written down–they want to write them off over time.

Only recently, Gundlach adds, there have been quiet discussions and "memos" among bankers and politicians in Washington about cutting the principal amounts owed on first mortgages on homes that are headed for foreclosure. There has been resistance to writing down principal since the beginning of the crisis. For one thing, many of the mortgages are owned by institutional investors that had been reluctant to agree to cut the amount of principal they would be repaid, Gundlach notes. In addition, there is fear of unintended consequences once principal is cut on some mortgage loans: will other homeowners, whose homes are underwater but who are still making their mortgage payments on time, purposely stop paying so that they, too, could negotiate a principal reduction, causing a chain reaction of defaults? No one knows the answer to that, Gundlach says.

Altering the mortgage's legal contract has also been an argument against forgiving principal of mortgage loans in this downturn. But if Bank of America is beginning this process, is it a sign that other lenders may look at principal reductions for mortgages as well?

Comments? Please send them to [email protected]. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.