WASHINGTON/NEW YORK - The Obama administration on Wednesday launched a $75 billion foreclosure relief plan, as new data showed one in five U.S. homeowners with mortgages owe more than their house is worth.

The mortgage plan, part of a $275 billion housing stimulus program announced last month, enables struggling homeowners to modify loans even if they are under water.

Homeowners with mortgages on about 8.3 million properties were under water at the end of 2008 and the distress is likely to grow as home values shrink, according to First American CoreLogic.

Being under water, or having negative equity, has previously ruled out refinancing. This new government step aims to reduce payments and prevent looming foreclosures for struggling borrowers and allow standard refinancing for stronger borrowers whose homes values have eroded.

The U.S. Treasury Department unveiled eligibility guidelines for the mortgage modification program that aims to target relief to people facing imminent hardship.

In issuing the guidelines, the Treasury opened the door to borrowers who are delinquent in their payments or at risk of falling behind to begin pressing for loan modifications.

The program, which offers cash incentives to loan servicers to cut monthly payments, will only modify mortgages on single dwellings up to $729,750 originated before January 1, 2009, with higher limits for multiple-unit owner-occupied properties.

Homeowners who stay current on modified loans will see their principal reduced by up to $5,000 and lenders will get additional incentives for extinguishing second-lien home equity loans.

Details of the program were announced ahead of an expected vote in the U.S. House of Representatives on Thursday on a bill that would let federal judges erase mortgage debt for homeowners who enter bankruptcy as a last resort. The bill, which also would shield firms that ease loan terms from investor lawsuits, is expected to be approved.

STEMMING A DEEP HOUSING SLIDE

U.S. home prices have swooned by more than 26 percent since peaking in mid-2006, based on Standard & Poor's/Case-Shiller indexes, and are widely seen sliding further.

The perfect storm of fast-eroding home values just as unemployment has climbed to a 16-1/2 year high has propelled foreclosures to all-time highs and thrust the U.S. housing sector into its deepest downturn since the Great Depression.

The Obama plan will provide some real relief for some people who need it, but I'm only modestly optimistic that we're going to see a significant reduction in foreclosures, said Mark Vitner, senior economist with Wachovia Corp in Charlotte, North Carolina.

He said restrictions on the program for loan amounts, owner occupancy and financial hardship would limit its effectiveness in key markets such as California, Nevada and Florida that have a high percentage of investor-owned homes in trouble.

And the recession is soon to produce another wave of foreclosures caused by job losses.

Labor markets are deteriorating and will continue to deteriorate, said Mike Schenk, senior economist for the Credit Union National Association in Madison, Wisconsin. Regardless of how affordable things get, those trends in labor markets are having a huge impact on confidence and on people's ability and willingness to make large financial decisions like purchasing a house.

LOAN DEMAND FALLS

Requests for loans to buy homes and refinance mortgages dropped for a second straight week last week as potential borrowers held back in hope of even lower mortgage rates and help from the Obama rescue program.

The Mortgage Bankers Association's total applications index slid by nearly 13 percent to about half the level it had reached earlier this year when loan rates fell to 4.89 percent. The average 30-year mortgage rate last week was 5.14 percent, the trade group said.

U.S. banking regulators on Wednesday urged lenders and mortgage servicers to participate in the loan-modification program to support home loan modifications.

By providing servicers and holders of eligible residential mortgages with incentives to modify loans at risk of foreclosure, the program will promote sustainable alternatives to foreclosures, five bank regulators said in a statement.

Foreclosure sales were an ironic bright spot for the ailing housing market in 2008, real estate data company Radar Logic said. These distressed transactions made up as much as a third of all activity last year, surging as all other sales fell.

Buyers recognize that those are at significant discounts versus what all other people are asking for homes and are migrating to those first, said Radar Logic chief executive Michael Feder.

In addition to details on the loan modification plan, the Treasury announced that lenders could begin refinancing mortgages owned or guaranteed by Fannie Mae or Freddie Mac on homes whose values have dropped.

The Obama administration's plans will help curb monthly payments and spur refinancing, but do little to help potential owners come up with the increasingly large down payments that lenders require, Feder said.

(Additional reporting by Jonathan Stempel in New York and Mark Felsenthal in Washington)

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