The revamped Hope for Homeowners program is likely to be rolled out soon without an adequate solution to a major problem: How to extinguish second mortgages for borrowers facing foreclosure.

As a result, the program, which so far has helped only 95 borrowers refinance into government-backed mortgages, could continue to struggle to gain traction, despite several key improvements.

The Department of Housing and Urban Development has been in talks for months with large national banks and their regulators on the size of payments necessary to induce the banks to relinquish the second liens.

But the negotiations have reached an impasse, with banks insisting on a higher level of compensation than the government is willing to pay, people familiar with the discussions say. Separately, the problem of second liens is also bedeviling the administration's efforts to encourage loan modifications and short sales.

The deadlock could overshadow several improvements HUD is making to Hope for Homeowners, which is the only federal effort geared toward homeowners who are deeply underwater on their mortgages.

More than 16 million homeowners were upside down on their mortgages at the end of the second quarter of 2009, representing nearly one-third of all homeowners with a first mortgage, according to Moody's Economy.com.

Lenders must agree to extinguish a second mortgage before borrowers can refinance their first mortgage under the program. As many as half of seriously delinquent borrowers have a second mortgage, such as a home equity or down payment loan, according to analyst estimates.

"We appreciate the fact that there will be some second lien holders that won't go for this," a senior HUD official told Dow Jones Newswires. "And the program isn't for everyone. But it will serve a substantial niche [of borrowers]."

The program may work for borrowers who don't have a second mortgage, as well as those who are so underwater that the second-lien holder has little hope of recovering anything, the HUD official said.

The Obama administration inherited Hope for Homeowners, which was conceived by congressional Democrats and enacted last year as part of sprawling housing legislation. Administration officials have worked to iron out kinks in the program, but the bulk of their efforts has gone to ensuring the success of their own initiative - a program to provide millions of homeowners with government loan modifications.

HUD will soon roll out a retooled version of Hope for Homeowners intended to bring the incentives more in line with those provided under the loan modification program. Payments for extinguishing second mortgages may even be more generous than under the loan modification. HUD officials are also making sure Hope for Homeowners loans can be packaged and sold into the secondary market so that the program's rates are comparable with general mortgage rates.

However, the cooperation of mortgage servicers, who are gatekeepers to the administration's foreclosure prevention programs, will be crucial. Servicers, already swamped by queries from strapped borrowers, must have the patience to pursue a refinance under Hope for Homeowners, which requires far more work than a loan modification under the Obama program.

The largest servicers - JPMorgan Chase & Co. (JPM), Wells Fargo & Co. (WFC) and Bank of America (BAC) - are also the largest holders of second mortgages, giving rise to concerns they may not act in borrowers' best interest. Banks may be reluctant to extinguish second mortgages if it means they will be required to immediately write off the mortgage.

Mortgage investors - many of whom are intensely interested in Hope for Homeowners and favor it over the government loan modification program - are deeply skeptical that servicers will play along. Laurie Goodman, a senior managing director of Amherst Securities Group, called the second-line problem "intractable" in a recent research note to clients.

She believes Hope for Homeowners won't be used extensively for loans that have been packaged and sold into private-label securities. However, just 36% of all non-performing mortgages in private label securities had second liens taken out with the first, she noted.

A JPMorgan spokeswoman declined to comment. Spokesmen for Wells Fargo and Bank of America didn't return calls requesting comment.

If Hope for Homeowners flops a second time, deeply underwater borrowers who qualify can always get their interest rates cut temporarily, to as low as 2%, through the government's loan modification program.

But over the long term, these people will have difficulty refinancing or selling their home, Andrew Jakabovics, associate director for housing and economics at the Center for American Progress, said. "You may end up with a lot more people trapped in their mortgages," he said.

Under Hope for Homeowners, qualified borrowers can refinance into a new, government-backed loan that matches the current value of their home, as long as the investor in the prior mortgage agrees to write off a portion of the debt. By contrast, people familiar with the program say servicers typically aren't forgiving loan principal as part of the government loan modification effort.

Glenn Boyd, head of U.S. Asset-Backed Securitization Research for Barclays Capital, said mortgage servicers will ultimately need to agree to substantial principal forgiveness in order to bring down default rates.

"Simply having your mortgage rate reduced won't be sufficient for many of these borrowers who are significantly underwater," he said.

-By Jessica Holzer, Dow Jones Newswires; 202-862-9228; jessica.holzer@dowjones.com