Will banks cut the principal on your mortgage?

Not very often, but Bloomberg suggests that they may be getting ready to do so. Courtesy of us taxpayers, no doubt.

By John Gittelsohn and Prashant Gopal

Jan. 7 (Bloomberg) — Efforts by U.S. banks to help distressed homeowners have focused mainly on temporary fixes such as interest-rate reductions that may only put off the day of reckoning, despite policy makers wanting them to do more.

Banks may be forced to resort to a remedy they’ve been trying to avoid — principal reductions — as another wave of foreclosures looms and payments on risky loans rise, Bloomberg BusinessWeek magazine reports in the Jan. 18 issue.

While interest-rate reductions or extending loan terms reduce homeowners’ monthly payments, they don’t give much comfort to borrowers who owe more on their homes than their properties are worth. Borrowers who don’t have equity in their homes are more likely to hand over the keys when they run into trouble. “The evidence is irrefutable,” Laurie Goodman, senior managing director of Amherst Securities Group in New York, testified before the U.S. House Financial Services Committee on Dec. 8. “Negative equity is the most important predictor of default.”

The foreclosure crisis is likely to deepen this year in part because payments on many adjustable-rate mortgages are set to balloon. Unless there’s a sharp recovery in property values or a change in lenders’ willingness to cut principal, at least 7 million borrowers currently behind on their payments will lose their homes, Goodman estimates.

Dueling Interests

The conflicting interests of mortgage lenders and home- equity lenders is a roadblock to doing principal reductions. Banks, credit unions and thrifts held $951.6 billion in home- equity loans as of Sept. 30, according to Federal Reserve data.

Mortgage lenders don’t want to cut principal unless the home-equity lenders agree to take a hit. Typically, though, the home-equity lenders are reluctant; much of the value of their loans would be wiped out.

The threat of lawsuits is also hampering principal reductions. In December 2008 money manager Greenwich Financial Services sued lender Countrywide Financial in New York State Supreme Court. Greenwich, which owns mortgage-backed securities, demanded 100 cents on the dollar for some Countrywide investments. The securities included loans on which Countrywide had agreed to cut $8.4 billion in principal and interest to settle allegations of predatory lending.