The Federal Housing Finance Agency (FHFA) is considering a plan that would help underwater homeowners who have filed for Chapter 13 bankruptcy protection.

With the approval of a bankruptcy judge, the borrower would make only principal payments – and no interest – on a Fannie Mae or Freddie Mac mortgage for five years.

A FHFA spokeswoman confirmed that such a plan is under discussion but did not provide any details.

However, with most 30-year fixed rate “vanilla” loans the borrower pays mostly interest during the first seven years anyway.

FHFA acting director Edward DeMarco is under pressure from House Democrats for refusing to consider a principal reduction option for borrowers who are underwater but current.

The so-called "principal paydown plan" was first reported by The Financial Times. The concept being discussed skirts principal reduction, which is considered controversial and carries with it a certain mortal hazard.

If implemented, the plan – developed by bankruptcy lawyers – would lower a borrower's mortgage payments under a five-year bankruptcy repayment schedule.

Such Chapter 13 repayment plans also address credit card and other unsecured debt so borrowers have a better chance of remaining in their homes.

"It's a very interesting idea that is definitely worth exploring more fully," said Glen Corso, managing director of the Community Mortgage Banking Project. "It appears to deal with the moral hazard issue and also deals with the unsecured indebtedness of the borrower.”
One of the flaws of modification programs such as HAMP is that the mortgage payment is reduced, but the borrower's other debt payments are not, keeping their overall debt-to-income ratio in the range of 61%.

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