The Surprisingly Simple Solution to Underwater Mortgages

Step One: Buy delinquent mortgages. Step Two: Actually work with homeowners to modify loans.

A house under foreclosure that is now bank owned in the Spring Valley area in Las Vegas on October 15, 2010. (National Journal)

Bob Stachler's life started to fall apart when his ex-wife passed away. When they divorced, she had kept the family home, and Stachler decided to buy it after her death to give his three teenage children some stability. The house on the suburban edge of Chicago's South Side was beyond what Stachler, a truck driver, could really afford as a single dad. But it was 2007, and getting a mortgage was easy. "I was thinking, I can do this. I'll keep my children in the house they grew up in," he says. Then, in 2009, Stachler lost his job. He started to default on his $1,785 monthly mortgage payments. "I thought I was destined to lose the house," he says.

Five years after the housing bubble burst, 10 million homeowners are struggling to make payments on "underwater" mortgages. Selling their homes won't free people like Stachler from their debt burden, because they owe more on their mortgages than the current market value of their houses. But many such borrowers could afford a mortgage that reflects the current price of their property — often much lower than the inflated price appraisers quoted at the height of the housing bubble.

That's the idea behind the Mortgage Resolution Fund, a partnership between four national housing nonprofits that aims to prevent foreclosures by buying bundles of delinquent mortgage notes and working with homeowners to either modify the loans or help families relocate. Since 2011, MRF has purchased more than 1,000 delinquent mortgages in distressed Ohio and Illinois neighborhoods. Stachler is one of those homeowners whose mortgage MRF now holds — and, thanks to a trial modification, his monthly payments have been reduced to $1,185. He can afford that sum now that he's back to driving a truck, and if he keeps making payments on time, the modification will become permanent.

Consumer advocates have been calling for an intervention like this since the beginning of the housing crisis. "The idea that troubled mortgages should be bought by somebody before they got into trouble ... at a discount and restructured to try to keep people in their homes was around right from the start of the crisis," says Barry Zigas, director of housing policy for the Consumer Federation of America. If all goes well, MRF will pay for itself: Revenues from the payments on modified mortgages, home sales, and other activities will create a stream of funding to cover new loan purchases. MRF's members have on-the-ground expertise in hard-hit communities nationwide, and the initiative has already found substantial success obtaining funding. But MRF is finding it hard to acquire mortgage agreements on a grand scale.

When the Housing Partnership Network, Enterprise Community Partners, Mercy Portfolio Services, and the National Community Stabilization Trust founded MRF, they envisioned buying hundreds of mortgage notes at a time from lenders such as Wells Fargo and Bank of America. They also wanted to concentrate purchases in communities most threatened by foreclosures.

But the mortgage-lending landscape is so fragmented that it's been hard for MRF to find a sizable, neighborhood-based portfolio to purchase. Most neighborhoods don't have a dominant lender or a dominant servicer processing payments. Many servicers are handling payments that have been pooled and sold to a range of investors — and investor agreements often limit what servicers can do to adjust their loan portfolios.

Worse, note holders are reluctant to sell to MRF at a price that reflects the current value of the property. Even though banks lose more money when homes goes through foreclosure than they would in selling discounted notes to MRF, they're wary of taking a step that would adjust the value of their loan portfolios. Selling off hundreds of notes at a discount would hurt investors and might spook the markets.

So far, MRF has been able to acquire only a handful of notes here and there from commercial players such as Citibank and Bank of America. And the initiative has hit a brick wall when it comes to the nation's largest servicers, Fannie Mae and Freddie Mac, which will work with borrowers to adjust interest-rate payments but won't modify loan principals.

The organization's biggest break came last year, when the Federal Housing Administration announced plans to auction off over 40,000 delinquent mortgages. The Housing and Urban Development Department's mortgage insurer wants to get rid of its worst-performing notes and hopes that private-sector bidders will be able to help homeowners. Ninety percent of the loans MRF holds today were formerly held by the FHA.

To raise money to purchase those notes, MRF worked with the Housing Development Authorities of Illinois and Ohio to access federal funds set aside for foreclosure relief. Illinois freed up $100 million Hardest Hit Fund dollars for loan purchases and gave $38.5 million to MRF as a no-interest, no-fee loan. Ohio created a $30 million program to support the purchase of notes by nonprofits, from which MRF has drawn $15 million. The split between public and private funds is a model MRF wants to replicate, says Becky Regan, president for capital market companies at the Housing Partnership Network.

Once the mortgage notes are in MRF's hands, the rest is almost easy. When MRF's servicers reach out to delinquent borrowers, the response rate is more than double that of a bank or government servicer, Regan says. People who are behind on their mortgage payments are far more likely to respond to a call or answer a letter from a community-based nonprofit than they are to respond to their bank.

MRF's resolution specialists have made contact with 71 percent of the Illinois homeowners whose notes it has purchased. Of those eligible for some sort of resolution, 43 percent have received loan modifications and 39 percent have entered into a process that will let them avoid foreclosure, either through a short sale or through deeding the property to MRF. MRF believes it will be able to keep more than one-third of its clients in their homes.

"A lot of it just comes down to trust," Regan says. People like Stachler have often given up on their bank and the government. Stachler's servicer, Bank of America, told him he couldn't be helped. His application for federal mortgage assistance wasn't processed for months; by the time it was, he had become ineligible. His MRF resolution specialist was the first person he spoke to who actually seemed to want to help. Says Stachler, "It seemed like she really wanted me to keep the house."

Correction: An earlier version of this article misstated the amount of Hardest Hit Fund dollars that the Illinois Housing Development Authority has set aside for Mortgage Resolution Fund. The correct amount is $38.5 million.