The collapse of the housing market has pushed more than 11 million homeowners into the uncomfortable position of owing more to their lender than their house is worth. A third of the mortgages held in California fall into this category, according to housing market analyst CoreLogic. Many of these borrowers are voluntarily defaulting on loans even though they could still afford their payments, calculating that their homes will never regain their value.

During debate last week on a bill (HR 5072) to shore up the Federal Housing Administration’s mortgage insurance program, the House decided to crack down on such “strategic defaults.” Lawmakers agreed to a proposal by Rep. Christopher Lee (R-N.Y.) to make those who strategically default ineligible for new FHA-insured loans. The ban sends the right message, but it’s not likely to make much of a difference to the borrowers mailing in their keys.

Surveys suggest that strategic defaults are rising fast, especially in California and other states where property values have tumbled sharply. One report last year estimated that there would be more than a million such defaults in 2009. And Moody’s Economy.com estimated that this category accounts for almost one-tenth of defaults by homeowners whose mortgage debt is at least 20% higher than their property values.

Part of the outrage about strategic defaults stems from anecdotal evidence of borrowers gaming the system, spending lavishly on themselves instead of paying their mortgage. Yet such excesses don’t explain why borrowers are choosing to default. For many, it’s a rational response to owning a house that may never be worth what they are investing in it. If they live in states that bar banks from recouping more from foreclosed borrowers than the value of their homes, defaulting may simply be a way to stop throwing good money after bad. The penalty these borrowers face is a precipitous drop in their credit ratings, making all forms of credit scarce and costlier. That’s far more serious than the potential loss of access to FHA-insured loans, which ordinarily account for just a fraction of available mortgages. Yet strategic defaults continue to climb.

It’s lenders, not lawmakers, who are best able to slow the pace of strategic defaults, because they’re the only ones who can narrow the gap between the diminished value of a house and the amount of its mortgage. Given how hard it is for banks to justify writing down debt when the borrower can afford the loan, the rise in strategic defaults may be unstoppable. Call it another price paid for the country’s housing folly.

The Fannie Mae program takes effect August 1, 2010 and is designed to mitigate the impact of foreclosures on borrowers who are eligible for a loan modification under the Home Affordable Modification Program (HAMP) but were unsuccessful in obtaining one, Fannie said. Like the Treasury Department’s HAFA program, servicers cannot consider a borrower for HAFA until the borrower is evaluated and eliminated from eligibility for a Making Home Affordable Modification Program (HAMP) workout plan.

Also like the Treasury program, Fannie Mae will offer servicers cash incentives for completed HAFA transactions, $2,200 for short sales and $1,200 for deed-in-lieu of foreclosure agreements. Borrowers are also eligible for $3,000 in incentives.

That’s more than in the Treasury’s HAFA program, where servicers are eligible for $1,000 and the borrower gets $1,500. In the Treasury HAFA, the investor is also eligible for a $1,000 incentive.

Participating servicers will be required to report on their Fannie Mae HAFA activities to both Fannie and the Treasury and the program sunsets on December 31, 2012.

After announcing the program in October 2009, Treasury’s HAFA program began in April. The Fannie Mae HAFA program is the latest in a string of programs designed to help borrowers avoid foreclosure. In addition to HAFA and HAMP workouts, Fannie Mae is letting some distressed borrowers stay in their homes as renters, under the deed for lease (D4L) program.

Also, in March 2010, Fannie Mae instructed its servicers to consider an “alternative modifications” for all mortgages that did not qualify for a permanent conversion under HAMP. That “Alt Mod” program, which sunsets on August 31, 2010, is similar to HAFA.

The program would provide $3bn from the Troubled Asset Relief Program (TARP) to lend up to $50,000 to unemployed homeowners, who could reasonably resume making payments again within two years. The program was modeled after the Homeowners’ Emergency Mortgage Assistance Program (HEMAP) in Pennsylvania.

The Senate passed the bill last week but transplanted its own language into the one passed by the House of Representatives. The status of the reform is still “resolving differences.” But, lawmakers hope to have it in front of President Obama to sign by the July 4, 2010 recess.

HEMAP has provided $236m to the unemployed to help with foreclosure relief. Rep. Chaka Fattah (D-PA) introduced HEMAP in Pennsylvania in 1983 and introduced it to the new federal bill before the Senate passed it. Fattah originally tried to introduce the bill to Congress in 2003, then again in 2007.

“American’s need help, 8% of all mortgage holders are currently at risk of losing their homes and that is unacceptable,” Fattah said.

Unemployment rose to 9.9% in April, according to the Department of Labor. The share of US mortgages at least 30 days delinquent or already in foreclosure did slip to 14% in Q110, but remain at heightened levels, according to the Mortgage Brokers Association (MBA).

That was the case for Victor and Patricia Mendez of Livermore. When demand began to slump for Victor Mendez’s tile contracting work, he and his wife asked their bank, JPMorgan Chase, for a loan mod.

“They said, ‘We can’t help you until you’re late,’ ” said Patricia Mendez. “It took a long time for me to get the guts to do that. I had never been late on anything in my life.”

The Livermore couple eventually did stop paying their mortgage, believing that was their best hope.

Chase denied that it had urged the Mendez family to become delinquent. In a statement, it said: “We have no policy to advise customers to stop making payments, and we can find no indication that we advised this customer to stop making payments.”

After several more months of calling and faxing in financial documents, the couple said Chase gave them a trial loan mod, temporarily reducing their payments.

Patricia Mendez said the couple made those trial payments for 10 months, while she took on a part-time job as a church secretary to improve their financial profile and Victor found extra work.

But at the same time, their credit rating steadily eroded as Chase first reported their missed payments and then recorded their trial payments as partial payments, she said. Credit card companies slashed their spending limits and raised their interest rates. The rate on one card jumped from 9 percent to 29 percent.

Devastating change

Because Victor Mendez’s work requires him to buy supplies, the poor credit was devastating. “To be a contractor without credit is nearly impossible,” Patricia Mendez said. “You have to buy job materials; you have to wait to get paid on jobs.” They had to juggle even more to come up with cash to buy work supplies, even cashing in an IRA.

Then, after 10 months, they got a letter from Chase saying they had been denied for permanent help and now owed $44,000 in past-due amounts and fees.

They have no hope of coming up with that amount, she said. The four-bedroom home where they live with their five children, ages 8 months to 19 years, was scheduled for a foreclosure auction later this month.

“We did everything (Chase) told us to and our credit was destroyed because of working with Chase,” Patricia said.

After being contacted by The Chronicle and by an attorney representing the Mendez family, Chase said it would review the loan for permanent modification because the family said it had increased income.

As for credit reporting, Chase spokesman Tom Kelly said: “We report to the credit bureaus when people don’t make their payment or their full required payment.”

“A lot of people don’t understand that by making the payments due on their temporary loan mod they’re reported as delinquent immediately,” said Margot Saunders of the National Consumer Law Center in Washington. “It’s a huge misunderstanding.”

For borrowers who do end up getting long-term relief, the credit hits may be worthwhile, said Ruth Susswein, deputy director for national priorities at Consumer Action.

“If this is the only way to keep your home, then it may not matter,” she said. “But if keeping your home doesn’t work out, and (the process) makes your credit score even lower, you’re in a much worse place. This puts consumers in such a bind.”

Modifying loans

If you’re requesting a loan modification, here are some steps you can take to try to protect your credit:

– Try to stay current on payments while requesting a trial modification.

– Try to get a loan mod under the federal Home Affordable Modification Plan (HAMP), which has less impact on credit.

– Request that the lender not report your trial loan payments as partial payments.

– Make your trial payments on time.

– Homeowners who believe that servicers are not treating them fairly or complying with program guidelines can contact the HOPE Hotline at (888) 995-4673.

Separately, the U.S. Census Bureau reported that single-family housing starts in April surged to a seasonally adjusted annual rate of 593,000, up 10.2% from March. Ivy Zelman, chief executive of research firm Zelman & Associates, said builders stepped up production ahead of the April 30 deadline for sales qualifying for a federal tax credit, but since then have cut back.

ReutersRealtor Steve Bremis, left, talks to house-hunters Makayla Gavitt and David Harris at an open house in Somerville, Mass., on Sunday.

The analysts surveyed by MacroMarkets on average expect home prices, as measured by the S&P/Case-Shiller national index, to rise about 12% in the five years ending Dec. 31, 2014. As of Dec. 31, that index was down about 28% from its peak level in mid-2006.

Some of the forecasters surveyed by MacroMarkets were far from the average. Joseph LaVorgna, an economist at Deutsche Bank, sees home prices rising 37% by the end of 2014. Both Anthony Sanders, a professor of real-estate finance at George Mason University, and Gary Shilling, president of A. Gary Shilling & Co., expect declines of about 18%.

Mr. Shilling, whose firm provides economic consulting and investment advice, said excess inventories, including those from looming foreclosures, will pull prices down. Mr. LaVorgna said a rapidly recovering job market should soak up most of that supply. He added that much of the excess supply is in remote or economically depressed regions and so isn’t relevant to most potential buyers, who will instead bid up prices in more desirable areas.

MacroMarkets, based in Madison, N.J., was co-founded by Robert Shiller, an economist at Yale University who helped create the Case-Shiller indexes. MacroMarkets creates securities that let people bet on the direction of various types of assets, including residential real estate. The survey by MacroMarkets was the first of what it says will be a monthly series involving about 100 analysts.

Mr. Shiller, who didn’t contribute a forecast for the survey, said in an interview that the average prediction of a 12% price rise over five years was “a plausible scenario.” During the housing boom, Mr. Shiller drew attention for bearish house-price comments that were far gloomier than the consensus but eventually proved to be on the mark.

The Census Bureau also reported that single-family building permits in April fell 10.7% from a month earlier to a seasonally adjusted annual rate of 484,000. Ms. Zelman said builders have slowed down now that it is too late for buyers to get the federal tax credit.

Before ramping up construction again, she said, builders will await signs that demand “isn’t falling off a cliff” after being temporarily buoyed by the tax credit.

Ms. Zelman forecast that single-family housing starts for all of this year will total 559,000. That would be up 26% from 445,000 in 2009, but still off 67% from the peak level of 1.72 million in 2005. Ms. Zelman expects demand to be constrained by high unemployment, tight credit and the large number of Americans unable to sell their current homes because they owe far more than the market value.

NEW YORK (CNNMoney.com) — The number of troubled homeowners falling out of President Obama’s foreclosure rescue plan soared in April.

More than 122,000 borrowers had their trial mortgage modifications canceled in April, bringing the total to 277,640 since the program began about a year ago, according to federal statistics released Monday. Meanwhile, only about 68,000 homeowners were converted from these trials to permanent modifications last month.

Under the program, known as HAMP, eligible troubled borrowers are put into trial modifications to determine whether they can keep up with the lowered payments and to give loan servicers time to verify income and hardship.

A total of 295,348 people have received permanent long-term help under the loan modification plan, but another 3,744 who were converted to permanent status were later cut from the program anyway.

Modifications are usually canceled if the borrower fails to make the adjusted payments, or if during the trial period, does not meet the program’s criteria or hand in the required income verification paperwork.

Administration officials said they were not surprised to see the number of canceled trial modifications spike. That’s because borrowers had been allowed to enroll in the trial program by simply stating their income. But they are being dropped if they cannot prove the figures they provided.

“As those decisions get made, it’s certainly expected that there would be some that fall out of HAMP,” said Phyllis Caldwell, chief of Treasury’s Homeownership Preservation Office.

So far, some 24.6% of trial modifications have become permanent, up from 19.8% a month ago.

Some 637,353 troubled borrowers remain in trial modifications, officials said. The pace of people entering the program has slowed as servicers begin implementing new requirements to collect documents at the outset.

Uneven performance

New statistics released by Treasury provide additional insight into just how well servicers are doing in converting trial modifications to permanent status.

The six servicers who verified borrowers’ income before placing them in trials have transferred more than half to long-term adjustments, with HomEq Servicing and Ocwen Financial Corp. (OCN) leading the way with 83% converted.

Those using stated income, however, have yet to hit the halfway mark. The largest loan servicers are trailing most of the pack with Bank of America (BAC, Fortune 500) at 25%, Wells Fargo (WFC, Fortune 500) at 25%, JPMorgan Chase (JPM, Fortune 500) at 22% and Citigroup (C, Fortune 500) at 21%.

Borrowers also languished in trial modifications at certain servicers. Some 76% of those in the trial phase at Saxon Mortgage Services and 72% at JPMorgan Chase have remained at that stage for at least six months. Servicers, who met with Treasury and Housing Department officials last week, told the administration they would clear the backlog by the end of June.

New rules on their way

Big changes to the program are coming down the pike in the wake of criticism that the administration must do more to help troubled borrowers.

Starting June 1, homeowners will have to provide all their income verification documents before they are put into trial modifications. This will make it harder for troubled homeowners to start the process, but it should make it easier for them to qualify for permanent assistance.

Separately, the administration plans to roll out its new program for the unemployed on July 1. Eligible borrowers could enter a forbearance program, which either suspends their monthly payments entirely or reduces them to less than 31% of their pre-tax household income.

Administration officials also plan to provide more details on the performance of the eight largest servicers in July. It will report the average time borrowers spend in the trial phase, the servicers’ handling of calls and problems and a review of whether borrowers were appropriately evaluated. This is another step in the government’s effort to put pressure on servicers to perform.

Later in the year, two more initiatives will begin. One will encourage servicers to lower loan balances for delinquent borrowers when that is more advantageous to mortgage investors than reducing interest rates.

Principal reduction would be available for eligible borrowers who owe more than 115% of their home’s current value. The balance would be forgiven as long as the homeowner makes timely payments for three years.

The other initiative will allow some borrowers who are current on their mortgages but have seen their property values drop, to refinance into Federal Housing Administration loans worth no more than 97.75% of their home’s price. The program is set to start in the fall.

If the borrower has a second lien, the total mortgage debt could not exceed 115% of the property’s value. Homeowners, however, must meet FHA’s qualifications and have a credit score of at least 500. Their new monthly payments would be no more than 31% of their monthly income.

Total workout solutions rose 92% to 1.36m from 710,000 in the year-ago quarter.

The mortgage industry completed 476,192 modifications in the quarter — a 29% increase from same quarter last year, Hope Now said. These modifications include internal modification programs and Home Affordable Modification Program (HAMP) permanent modifications, as reported monthly by the Treasury Department.

In Q110, the industry completed 312,329 proprietary loan modifications and 163,863 permanent HAMP modifications, Hope Now said.

Meanwhile, foreclosure starts fell 5% to 691,020 from 728,780 in the year-ago quarter. Delinquencies of 60 or more days, however, jumped 40% over last year to 3.99m in Q110. Completed foreclosure sales are also up 45% to 291,380:

“It is clear our work is far from over,” said Hope Now executive director Faith Schwartz in an e-mailed statement. “Alliance members have demonstrated their commitment to helping homeowners, their ability to find workable solutions and their willingness to implement multiple intervention solutions to stabilize markets and homeowners.”

The quarterly data arrives as Schwartz is announcing her resignation from the post of Hope Now executive director effective June 1. Schwartz tells HousingWire she will continue as a senior advisor to Hope Now in the coming months.

“It has been a terrific role,” she says. ”I have no plans at the moment other than spending more quality time with my three children over the summer months. Then I will finalize my next steps. No doubt, I will remain active in this space.”

Eric Selk will continue to manage the outreach events, according to Schwartz. The day to day on-site manager will be Larry Gilmore, who is also CEO of Hope LoanPort.

The lower house of parliament in Berlin today voted 390 to 72 in favor of Germany’s share of the 110 billion-euro lifeline from the euro-region and International Monetary Fund that will allow Greece to avoid default. The upper house, or Bundesrat, where Germany’s 16 states are represented, also backed the bill. The fact Germany anteed up is a relief now but Greece is bankrupt and providing $164B in aid is a bandage on a sunken chest wound. Spain Portugal, Italy and Ireland are facing potential debt problems and may need that and more assistance to avoid defaults.

This morning’s April employment report was much better than markets were expecting; non-farm job growth jumped 290K jobs while expectations were for an increase of around 200K. The view that the anticipated gains would come mostly from temp census workers was wide-spread, that didn’t happen. The number of census workers was just 66K, most jobs came from the private sector

Here are some facts and figures about the Dow’s big day and where it stands, provided by Dow Jones & Co.:

The Dow Jones industrial average closed down 347.80, or 3.2 percent, at 10,520.32, its biggest point loss since February 2009.

It had been down as much as 998.5 points, or 9.2 percent, the biggest intraday point drop in its history.

The Dow is now down 631.51 points, or 5.7 percent, the past three days. That’s the biggest three-day point drop since November 2008 and the biggest three-day percentage drop since March 2009.

The index had a swing of 1,010.14 points between its highest and lowest levels of the day.

The Dow is 25.7 percent below its record close of 14,164.53 on October 9, 2007.

It is up 60.7 percent from its 12-year low close of 6,547.05 on March 9, 2009.

Despite its big losses this week, the Dow is still up 0.9 percent so far this year.