Study’s Show Small Loan Modifications Failing

One third of all subprime loans modified in the third quarter of 2007 were delinquent again within 10 months, according to a Credit Suisse report. A study by Moody’s ratings agency showed similar results. Looking at subprime adjustable-rate mortgages (ARMs) modified in the first half of 2007, the agency found that by March 2008, only a third were still current or had been fully paid, and two-thirds had fallen back into default.

Last month, the HOPE NOW Alliance reported that its members had made 98,000 loan modifications in September alone – a monthly record for modification workouts. While the industry is pressing forward with trying to preserve homeowners’ American dreams by offering modifications instead of proceeding with foreclosure, these studies show that there are still challenges to lenders’ loss mitigation efforts.

Consumer groups argue that part of the re-default problem is lenders’ reluctance to make the sorts of changes that will really improve a homeowner’s chances, a report in Time magazine said. Many think of a loan modification as lowering interest rates or reducing the overall loan balance. However, one of the most widely used adjustments is to simply spread missed payments over the remaining life of the loan, which has the contrary effect of raising, instead of lowering, the homeowner’s monthly payment. According to the nonprofit Center for Responsible Lending (CRL), nearly half of the loan modifications reported by HOPE NOW have left homeowners with the same or higher monthly payments, Time reported.

Going back to that Credit Suisse study, researchers found that 44 percent of loans with increased monthly payments became at least 60 days delinquent within eight months. On the other hand, reducing interest rates or principal had a much better chance of working. According to data from Credit Suisse, only 15 percent of loans that had received an interest-rate reduction and 23 percent in which the principal balance had been reduced were more than 60 days delinquent after eight months.

With approximately 3.5 million U.S. homeowners currently behind on their mortgage payments, lenders face pressure from every side to find a workable solution to stave off foreclosure. Long-term modifications that bring mortgages into the range of “affordable” allow homeowners to stay in their homes, lenders and investors to recover more capital than they would see from a foreclosure in today’s market, and mean that fewer vacant, foreclosed properties hit the marketplace. Many would argue that’s a “win” on every side.