Mortgage Re-Default Rates High After Early Modification Efforts

(Oct 12, 2009) Lenders had been all too willing to restructure a delinquent borrower’s payment schedule so they could in turn catch up on all back payments due, however lenders had fallen short of modifying a borrower’s loan so that a long-term improvement to the terms of the loan would result in the end. The conclusion of a prolonged modification process typically resulted in forbearance by the lender, providing a borrower more time to make good on what they owed, and yet no meaningful reduction in the rate, payment or principal due was granted to the borrower. More than half of the homeowners receiving this type of pseudo loan modification were delinquent again by two or more payments one year later. Borrowers whose loan payments were not reduced, or were actually increased to cover back payments, re-defaulted again at a rate of 60% or more. Yet only one third of borrowers whose mortgage payments were reduced by 20% or more went on to re-default again. This sends a clear signal to lenders, loan servicers and investors that a reduction in one of the components of the loan, either to the rate and payment or to the principal will be required if they want the borrower to continue making their payments in the long run.

The Obama Administration’s response to the foreclosure crisis, the $50 billion Making Home Affordable program, has produced some promising early results since getting off the ground in the spring of 2009. The program is offered exclusively to borrowers who have mortgages which were acquired by GSEs, Fannie Mae or Freddie Mac. The program begins with a trial modification period of 3 months before a full modification is completed, which is then in force for a period of 5 years. By the end of August 2009, approximately 12% (or 360,000) of borrowers eligible to participate in the program had modifications initiated. Yet concerns continue to mount over the oncoming wave of option-ARMS, also known as “pick-a-pay” loans, which are soon scheduled to re-set or adjust their rates upward. These loans are particularly problematic because option-ARM borrowers started with rates as low as 1% and were permitted to defer some of the interest payments on their loan and therefore may have accumulated negative equity, perhaps up to 125% in some cases. By the end of the second quarter, 10% of these loans were in foreclosure at a rate 3 times that of all other mortgage categories. Keeping option-ARM borrowers in their homes could prove to be a particular challenge as many have been left with a zero to negative equity position in their home. Maintaining some level of equity or “skin in the game” seems to be an essential element in motivating borrowers to stay on and continue making their payments. An unfortunate consequence of an escalating unemployment rate is the wave of debt payment delinquencies and with close to a third of all outstanding mortgage borrowers already underwater on their loans, this will make a recovery in home prices as well as improving foreclosure figures difficult to achieve any time soon.

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