Getting heads above water
To stop foreclosures, housing advocates want Seattle city leaders to embrace a new tool called principal reduction
Chettie McAfee wanted to keep her home.
After losing her job as an account executive for a medical diagnostics company, McAfee had enough to survive for a while using her savings and retirement, but she hoped to get a lower monthly payment and interest rate on the $550,000, six-bedroom South Seattle home.
In 2008 she called Chase Bank. A customer service representative told her that she wouldn’t be eligible to change the loan until she missed three payments. So McAfee didn’t pay her mortgage for three months.
Then, she waited. She sent in paperwork nine times and tried to sell her home to settle the debt and keep the looming bank foreclosure at bay. None of it worked. She never received her loan modification.
In 2013, McAfee sued Chase, Wells Fargo and several other companies involved in her loan.
McAfee isn’t alone. More than 2,000 Seattle homes are in some state of foreclosure, and many more are underwater, meaning the mortgage holder owes more for the home than it is worth. These are the remnants of the 2008 recession, when the housing market burst and home prices dropped.
“You can imagine me times many more people,” McAfee said. “Some people have the capacity to withstand it, and some do not.”
The Seattle City Council is discussing ways the city could lower the debt amount for people who are facing foreclosure, following the lead of cities like Richmond, Calif., and Irvington, N.J.
Housing advocates are encouraging city of Seattle lawmakers to pursue this mechanism, called “principal reduction,” in which the city compels private companies to sell underwater mortgages to the city for fair market value so the city can lower the debt and prevent foreclosure. Lawmakers in Richmond and Irvington have passed this type of legislation.
Advocates say because of decisions made on Wall Street, principal reduction is the only way to help people who are struggling with their mortgage.
“We didn’t create this crisis, and we didn’t create the housing bubble,” said Chris Genese, of foreclosure activist group Reset Seattle.
Banks and free-market advocates oppose principal reduction, arguing it will lead all homeowners to demand breaks on their debts, whether or not they need it.
“That is not going to lead to more affordable mortgages, it’s not going to improve the housing situation; it’s going to make things worse,” said Norbert Michel, a research fellow for the Heritage Foundation, a conservative think tank in Washington, D.C.
Costs of foreclosure
Supporters of principal reduction say it is the only way to help the 11 to 13 million Americans who are underwater on their home loans.
The presence of too many underwater mortgages hurts home owners and the housing market, said Robert Hockett, a Cornell University law professor who studies the foreclosure crisis and is advising cities on principal reduction plans. Homeowners stand to lose their homes through foreclosure. In cases where homes are 20 percent or more underwater — meaning they are worth at least 20 percent less than the total mortgage — nearly 70 percent of home owners will likely default, meaning they missed multiple payments and lenders may foreclose.
Foreclosures, which ruin the homeowners’ credit ratings, also cost lenders tens of thousands of dollars each to manage.
Many homeowners’ attempts to convince banks to adjust loans are unsuccessful, Hockett said. McAfee’s mortgage is called a private labeled securitized loan (PLS), common before 2008. Banks manage pools of PLS loans for a group of investors.
A contract between the bank and investors restricts the number of loans on which banks can reduce the principal. Often, this is no more than 5 percent of the total loans in the pool, Hockett said. A super majority of the investors must agree to a change in the contract.
Jill Smith, a lawyer for the Natural Resource Law Group, which is representing McAfee in a lawsuit, said homeowners have few options.
“The only way to stop foreclosures is to get a restraining order and sue,” Smith said.
Enter eminent domain
Principal reduction programs are a way for cities to step in and force the banks and lenders to reduce the principal on loans.
Richmond passed a law in 2013 that would allow the city to purchase a group of underwater mortgages at market rate from the banks and then adjust the principal, or the total amount owed. With a lower principal, the homeowners can get a lower monthly payment and are more likely to keep their homes.
The city of Richmond made an offer to banks in 2013 to buy 624 underwater mortgages, but the banks declined.
Now the city is preparing to use eminent domain, a mechanism in which a government can force a private company or individual to sell property for the public good. Cities often use eminent domain for construction projects, to build a road or highway through private land.
A plan for Seattle?
Principal reduction appeals to the Seattle City Council, particularly to Councilmember Nick Licata.
Members of the city staff are wary, however. A team of city officials from the city’s Office of Housing, the City Attorney’s Office, Finance and Administrative Services and the city’s Budget Office argued against principal reduction at a March 26 meeting.
Because no other city has pulled it off, city officials are wary of blazing a trail, stating in a report, “The significant legal and financial implications of this untested strategy outweigh its potential benefits.”
The group recommended outreach and education instead, irking advocates for homeowners.
“Quite frankly it just doesn’t feel like they spent any time thinking about how to help families or how to achieve principal reduction,” said Genese, of Reset Seattle.
Licata agreed and directed the group to do more research into principal reduction, whether through eminent domain or another mechanism.
Councilmember Kshama Sawant suggested a further step: “I think we should, at some point, be having a serious discussion about enacting a moratorium on foreclosures.”
The committee will report back in June with further recommendations.
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