Just a Band-Aid on the Foreclosure Problem?
Tuesday, February 3, 2009
Many homeowners who have been given a break on their troubled mortgages quickly end up in trouble again, a growing problem that is bedeviling efforts to stem rising foreclosure rates.
A recent study by the Office of the Comptroller of the Currency found that more than 50 percent of troubled homeowners had missed at least one payment six months after a lender modified their loan, and lenders and other researchers report similar default rates on modified mortgages.
The high default rate on reworked mortgages is complicating efforts to address a housing crisis that is already among the worst on record. It has sent government and industry officials scrambling to find new fixes as President Obama's administration pledges to spend $50 billion to $100 billion to help homeowners. A 50 percent recidivism rate "is an indicator that there are problems," said John C. Dugan, comptroller of the currency, whose office regulates some mortgage lenders. "Not just that the number is high, but that it keeps getting worse each month."
Many in Congress are questioning the effectiveness of loan-modification programs launched by the banking industry last year. "It's been going on for a year and half. The industry said, 'Don't worry; we have it under control.' It is painfully clear that sustainable voluntary modifications just aren't happening," said Rep. Brad Miller (D-N.C.). Miller is pushing legislation -- opposed by the financial services industry -- to allow bankruptcy judges to modify mortgages on primary residences.
"It's troubling to see a large number aren't staying current, but we don't know why," said Faith Schwartz, executive director of Hope Now, an alliance of lenders. "It can be because they lost their job. It's something new that has happened."
Most modifications aim to prevent foreclosure, and they succeed at that in the short term. The question is whether they work in the long term, or even for more than a few months. A review of reports indicates that the success of a modification can hinge on the type of changes the lender makes. According to a recent Credit Suisse report on subprime loans, those that were modified by lowering the interest rate or the principal balance owed were the least likely to become delinquent again. Modifications in which lenders simply gave homeowners time to catch up but raised monthly payments to cover missed amounts and late fees, or lowered interest rates for a time but then restored the rates to their previous level, were the least successful.
Jeanine Wilson continues to struggle despite modifications to the mortgage on her Upper Marlboro home. Her first modification, in May, increased her payments by $200 a month after her lender attached late fees and the missed payments. The second modification came after she was laid off as a social worker for the District government. Her interest rate was reduced, but though she was holding two new jobs, she still continued to miss payments, she said.
"They just kept saying they were in the business of making money, not in the business of helping you save your home -- either you pay it or you don't pay it," Wilson said.
In a recent study, Alan M. White, an assistant law professor at Valparaiso University, found that even with housing prices dropping rapidly, lenders have been reluctant to lower the borrower's principal. Instead, the average modification adds $10,000 to the principal owed by the homeowner, he found.
That has contributed to a higher re-default rate, White said. "Negative equity is the biggest predictor of re-default," he said. "If you have equity, you can always sell your house and you get some money and get a fresh start. . . . They are less motivated to struggle to make payments if they are underwater on their house."
In other cases, problems have occurred because the mortgage modifications were done without sufficient information, experts said. Charles W. Scharf, J.P. Morgan Chase's chief executive for retail financial services, said that when his bank bought Washington Mutual and Bear Stearns last year, it knew there were hundreds of thousands of troubled mortgages between them. But it was a surprise that many borrowers were not required to prove their income before receiving a modification. The result is that homeowners got modified loans they could not afford.
"A lot of the modifications that have been done were not exactly the most intelligently done," Scharf said. J.P. Morgan began applying its income-verification requirement to the loans acquired in October and expects performance to improve significantly, he said.