Obama administration pressures banks to reduce mortgage principal

The Obama administration is putting more pressure on banks to help underwater borrowers by reducing the principal on current home loans.

"We are continuing work with the issuers of the mortgage, the bank or service company to convince them to work with homeowners who are paying to see if they can modify the loan and possibly lower principal so that they are not burdened by these huge debts," President Obama said during the Twitter town hall meeting Wednesday.

With national home prices falling 33% from the peak before the housing crisis, many borrowers are now left with properties worth less than the amount owed on the mortgage.

Nearly 30% of current mortgages are in negative equity, according to Lender Processing Services (LPS: 19.82 -3.51%).

The administration's Home Affordable Modification Program has done little so far to address negative equity. Servicers participating in HAMP reduced the principal on roughly 5,000 mortgages since the program launched in March 2009.

"We are going back to the drawing board to put more pressure on banks to see if we can help more homeowners through modification and see where reducing principal is possible," Obama said.

David Motley, president of the Dallas-based servicerColonial National Mortgage, said any expanded program that gives homeowners a chance at principal reduction could promote a wave of strategic default.

"In such 'one-on-one' situations, principal reductions might work, but codifying them as part of a large scale program would be disastrous to the future of mortgage lending. Moral hazard would drive MBS buyers away in droves," Motley said.

Obama did admit the process is difficult but that there is room for banks and homeowners to both benefit from a principal reduction in lieu of foreclosure or strategic default. He also added no federal program will ever be large enough to solve the housing problems and he will lean on private companies to make the commitment.

"We try to match them up with bankers so each side is winning so that the mortgage owner can still stay in the home and still pay what's owed. That process will be difficult," Obama said.