Lenders cold to the idea of forgiving mortgage debt

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A mortgage broker has an idea for reducing foreclosures: Encourage lenders to forgive debt. So far, the notion hasn't gained traction. Jeff Lazerson, founder and president of the online brokerage Mortgage Grader, believes that some foreclosures could be prevented if delinquent borrowers could refinance their loans, but with some of the debt forgiven. This type of transaction, called a short refinance or short refi, is rare. Lazerson wants to set up a streamlined system to make short refis more common.Greatly simplified, this is how a short refinance works: You owe $200,000 on a house that you bought at the top of the market. Since then, house values in your neighborhood have fallen by 20 percent, and your house is now worth $160,000. The rate on your subprime adjustable-rate mortgage has gone up, and you can't afford the higher payments. Instead of foreclosing, the lender agrees to forgive $40,000 of the debt and refinances the mortgage for $160,000 -- a loan you can afford. "The lenders are going to take a hit anyway," Lazerson argues. "The biggest thing this does is prevent the number of documented foreclosures happening in a neighborhood and causing the values to deflate. It keeps people in their homes." Lazerson is pushing for his company to be part of the solution. He proposes to have Mortgage Grader negotiate short refinances on behalf of borrowers who otherwise would lose their homes through foreclosure. The Department of Housing and Urban Development, or HUD, provides funding to some housing counseling agencies, and Lazerson asked HUD to direct those agencies to refer their foreclosure-bound clients to him. Under the proposal, Mortgage Grader would have received $1,495 for each successfully negotiated short refi. HUD declined because it doesn't endorse mortgage companies and didn't have the money. Lazerson approached the Hope Now coalition of housing counselors and mortgage servicers, which turned him down without explanation. Even if he did get the go-ahead to negotiate short refis, Lazerson might meet with nothing but frustration. "They can't make the banks do it, No. 1," says Ellen Bitton, owner of New York-based Park Avenue Mortgage. "No. 2, who is going to be the banker who says, 'OK, I'm going to take this loan that's in foreclosure, and I'm going to refinance it and take a $100,000 hit?'" Few bankers will willingly do that, attests Michelle Lewis, president of Northwest Counseling Service, an agency in Philadelphia that helps homeowners who are in danger of foreclosure. She says she's all for negotiating debt forgiveness. "And that's been something we've been working on for years -- but we have had no success," Lewis says. There's no incentive for mortgage servicers to approve short refis, she says, because servicers believe they lose less money by foreclosing than by forgiving debt.It's hard enough to get a short refi as it is. A homeowner has to be past due for demonstrable reasons, with few prospects for catching up by reducing expenses or increasing income. A foreclosure is the outcome of most such cases. Or the homeowner can surrender title and move out voluntarily in what is called a deed in lieu of foreclosure. In other cases, the servicer might approve a short sale -- a sale of the house for less than the loan balance, with the remaining debt forgiven. Or, if the homeowner is persistent and lucky, a short refi might be arranged.A short refi won't happen unless the homeowner is willing to undergo a financial review and permit an appraisal with inspections inside and out. All stakeholders -- the servicer, borrower, mortgage insurer and any lender extending a second mortgage -- would have to approve a deal, agreeing that a short refi would lose less money than other options. Elizabeth Warren, a professor at Harvard Law School who is an expert on bankruptcy and consumer credit issues, says debt forgiveness "is our best shot for getting out of the mortgage crisis without destroying value through foreclosures. More foreclosures will only hurt the lenders and homeowners involved, they will also depress the real estate market for everyone else." But from a mortgage servicer's perspective, a request for a short refi might sound like extortion, as if the borrower were saying, "Forgive some of the debt that I willingly took on, or I'll stop making payments altogether." "It almost encourages everyone to say, 'Hey, maybe I'll stop making payments for a few months and the lender will refinance me,'" says Neil Garfinkel, partner in charge of real estate services for the New York-based law firm Abrams Garfinkel Margolis Bergson. "How do you prove that someone's just not gaming the system?"X...X...XThe benchmark 30-year fixed-rate mortgage fell 13 basis points, to 5.75 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.36 discount and origination points. One year ago, the mortgage index was 6.26 percent; four weeks ago, it was 6.21 percent.The benchmark 15-year fixed-rate mortgage fell 17 basis points, to 5.28 percent. The benchmark 5/1 adjustable-rate mortgage fell 14 basis points, to 5.67 percent. As usual, the 30-year jumbo, for mortgages exceeding the $417,000 conforming limit, fell less rapidly -- down 5 basis points, to 6.98 percent.The benchmark 30-year rate hasn't been lower than this since July 6, 2005, when it was 5.7 percent.Reach Holden Lewis at hlewis(at)bankrate.com. For more stories visit scrippsnews.com