Jeff Turner/Flickr
Jeff Turner/Flickr

Some struggling homeowners may soon have a shot at securing a type of mortgage relief that’s been off limits to them for years.

The mortgage finance giant Freddie Mac has agreed to sell a chunk of its most troubled loans to an unnamed investor. That investor can now turn around and reduce the size of the borrowers’ mortgages if it chooses –- an option that would not have been possible had the loans stayed with Freddie.

Freddie, its larger rival Fannie Mae, and their regulator have steadfastly refused to allow such “principal reductions,” fearing in part that the arrangements would entice homeowners to intentionally default on their mortgages so they can get better deals. (More on that topic here.)

By selling $659 million in unpaid principal balances to the investor, Freddie is basically opening up a wider range of modification possibilities for those mortgages.

“My assumption is that they’re selling the loans because investors have a broader tool kit than they do,” said Laurie Goodman, director of the Urban Institute’s Housing Finance Policy Center. “Clearly Fannie and Freddie can’t do principal reductions, so it’s a way around that.”

Mortgage debt forgiveness is considered one of the most effective ways to ward off foreclosure for borrowers who are "underwater." These borrowers owe more on their mortgages than their homes are worth, which leaves them vulnerable to foreclosure because they can’t sell or refinance if they run into financial trouble.

In a recent statement, Freddie said it selected the investor out of 22 bidders who took part in a competitive auction at the end of July. The deal, which is expected to close at the end of this month, is the first sale of its kind for the McLean-based company.

Freddie does not make loans. Together with Fannie, it buys mortgages from lenders, packages them into securities and sells them to investors. For a fee, it insures the loans and pays investors should a loan go bad.

If a borrower falls behind on a mortgage for more than four months, Freddie takes the loan back, pays the investor the principal owed on it, and keeps the loan in its own portfolio.

Last month, Freddie grouped together some of its defaulted loans and sold them at a discount  to get them off its balance sheet. Freddie declined to disclose the number of loans sold.

A person familiar with the sale said the goal was not to allow for principal reduction but rather to offload some severely delinquent loans. But the person, who is not authorized to speak publicly about the sale,  confirmed that the investor can do whatever it wants with the loans now that the loans are no longer subject to Freddie's rules.

The Federal Housing Administration launched a program nearly two years ago in which it sells defaulted loans to investors, including non-profit groups. Under that initiative, foreclosure proceedings are delayed for at least six months. The investors can work with the borrower during that time to devise a plan that pulls the homeowner out of default – including principal reduction.

FHA's most recent round of sales took place in June and July. The agency expected to sell  more than 40,000 distressed loans last year, with the goal of  helping beef up FHA's finances while stabilizing neighborhoods hard-hit by foreclosures.  The agency has yet to release the program's results so far, though it plans to do so in coming weeks.

Mark Zandi, chief economist at Moody's Analytics, said that while these types of sales open the window a crack for borrowers seeking principal reductions, mortgage debt forgiveness is often a last resort.

"You want the tool in your tool kit, but it’s a tool you pull out at the end, after you’ve tried everything else, because it’s very costly and you risk creating a moral hazard problem," Zandi said. "You would only want to do this in a very careful and judicious way."