Debt forgiveness a rarity

Debt forgiveness a rarityFew 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.
She adds that, "occasionally, on a case-by-case basis," clients have had debt forgiven, but only after filing lawsuits.

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. And they fear that debt forgiveness would bring out the scammers.

Debt forgiveness isn't scary, but foreclosure is, and the threat of it keeps homeowners in line. "While we're seeing mass foreclosures, many (borrowers) are paying under these terms that some would call onerous," Lewis says.
Government plan benefits fewIn December, the Treasury Department and HUD announced a plan to help homeowners with onerous loans, but not with debt forgiveness. The plan would aid the small number of people who could afford the introductory rates on their subprime adjustable-rate mortgages, but couldn't afford the higher payments after the rate jumped. Those people would have their introductory rates frozen for up to five years.

A homeowner taking advantage of the rate-freeze plan will end up making payments on a house that's worth less than the loan amount. That's not necessarily in the homeowner's best interest. A borrower would pay less every month if some of the debt was forgiven and the loan balance (and monthly payment) reflected the home's market value.
When you look at it that way, mortgage investors fared quite well in the plan brokered by the secretaries of Treasury and Housing. The rate freeze is friendlier to Wall Street than it is to Elm Street.

"We've really got no bailout for consumers, except through individual litigation, which is costly, but the market gets all kinds of bailouts," Lewis says. "Every effort to correct this leaves the loan whole. All the measures to figure out what to do with the people who got these loans still pay the lender for the bad behavior. It's crazy."
In December, even as the Treasury and Housing secretaries pushed a rate freeze instead of debt forgiveness, the president signed a law, called the Mortgage Forgiveness Debt Relief Act, that cuts taxes on homeowners whose debt is forgiven.

"So this bill will create a three-year window for homeowners to refinance their mortgage and pay no taxes on any debt forgiveness that they receive. And it's a really good piece of legislation," President Bush said. "The provision will increase the incentive for borrowers and lenders to work together to refinance loans -- and it will allow American families to secure lower mortgage payments without facing higher taxes."
Short refi in lieu of foreclosureThe law might give borrowers a tax break, but contrary to what the president says, it doesn't provide incentives for lenders to refinance with debt forgiveness instead of foreclosing. The law doesn't give lenders and mortgage servicers tax breaks or subsidies for approving short refis.

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.
For debt forgivenessLazerson believes there would be many instances in which a short refi could be demonstrated to be the best choice. He would commission two appraisals -- one for the home's fair market value and another for the home's "REO value," or real estate owned value -- what it could be expected to fetch in a quick sale after foreclosure. In neighborhoods with a lot of empty and foreclosed homes for sale, the REO value might be so much lower than the fair market value that the servicer would be willing to approve a short refi rather than foreclose.

He cites the work of Dan Immergluck, an associate professor of city and regional planning at Georgia Tech, who wrote a study concluding that each foreclosure knocks about 1 percent off the value of every house within an eighth of a mile. By that reckoning, a cluster of foreclosures can reduce surrounding home values enough to trigger more foreclosures.
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."
To Lazerson, it's a no-brainer: If foreclosures lead to more foreclosures, lenders should halt the snowball before it gains momentum by approving short refis.

"They just take the hit on the debt forgiveness, because they're going to take a hit anyway," Lazerson says. "In either case (foreclosure or short refi), they're going to take a loss."
Against debt forgivenessFrom 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?"
That's the same question that Bitton has. It's why she has reservations about the rate-freeze plan, too.
"It's almost encouraged people to be late on their mortgages," she says.
Garfinkel's and Bitton's reservations are about moral hazard: The idea that people act recklessly if they are insulated from the consequences of their actions. Lazerson replies that moral hazard applies not only to borrowers, but to lenders, too.

"What about the moral hazard that they caused in the first place, by offering these loans for people who had no business being homeowners?" he says. "The lenders were just counting their money and they really created this whole thing. Had they not offered these loans, you wouldn't have to be choosing which borrowers are deserving or not deserving."

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