Tuesday, December 23, 2008

Loan Modification Quality Matters

Posted by Tara Twomey on Credit Slips:

Yesterday new foreclosure and loss mitigation data was released by HOPE NOW in its "Loss Mitigation National Data July 07 to November 08" and by the OCC/OTS in their "Mortgage Metrics Report."

Combined the reports show a steadily increasing number of loan modifications and a slight decrease in foreclosures. That's the good news. The bad news is a large number of loans that have been modified are redefaulting. The OCC/OTS report shows 37% of loans were 60 or more days delinquent after six months. Here's an example to put this in real numbers. The HOPE NOW report shows nearly 870,000 loan modification in 2008. Using the 37% redefault rate means that just over 317,000 borrowers will enter the foreclosure pipeline again within 6 months.

The reasons that borrowers are falling back into default is the source of much debate. Industry representatives claim that every modification is affordable when it is made and borrowers redefault because their circumstances change. Consumer advocates argue that servicers are not creating long-term, affordable loan modifications.

Whose side does the data support?

Here's the rub. The data provided by industry is practically useless in determining the quality of loan modifications. For example, OCC/OTS defines a loan modification as a "Mortgage for which terms of the loan are contractually changed with respect to interest rates or other terms of the loan." HOPE NOW's definition provides: "A modification occurs any time any term of the original loan contract is permanently altered. This can involve a reduction in the interest rate, forgiveness of a portion of principal or extension of the maturity date of the loan." Under these definitions a three-month rate freeze and a life-of-loan interest rate reduction are both counted as loan modifications. Similarly, the capitalization of arrears, which increases the principal balance, and principal forbearance or forgiveness both fall in the loan modification box.

The best publicly available data that we have comes from
Prof. Alan White. His most recent analysisshows that "[o]nly 35% of modifications in the November 2008 report reduced monthly payments below the initial payment, while 20% left the payment the same and 45% increased the monthly payment." Prof. White also notes that many of the modifications being made are temporary (5 years or less) and that some include balloon payments or other negative amortization features that will be problematic down the road. With this quality of loan modification, it is not surprising many borrowers have already redefaulted or that more borrowers will redefault in the future.

Industry has focused their attention on increasing the quantity of loan modifications, but resolving the foreclosure crisis will take more than higher loan modification numbers. If we want to keep families in their homes, loan modification quality matters.

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