How to really help troubled homeowners

Tying mortgage modification to affordability lowers redefault rate, federal study finds. Regulators press banks to keep in mind borrowers' ability to pay.

EMAIL  |   PRINT  |   SHARE  |   RSS
 
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By Tami Luhby, CNNMoney.com senior writer

Map
Where does your state rank?
Americans everywhere are feeling the recession's pain – some more than others.
Do you think the job market is getting better?
  • Yes
  • No, it's getting worse
  • No, it's the same

NEW YORK (CNNMoney.com) -- It may seem obvious: Increasing how much troubled borrowers pay on their mortgage leads to redefaults. But that didn't stop America's banks.

Until the end of last year, the majority of loan modifications either increased homeowners' monthly payments or left them unchanged. Not surprisingly, more than half of those borrowers fell behind again within six months.

Loan servicers, the companies that collect mortgage payments and work with borrowers in default, have gotten the message.

A government report released Friday found that about half of modifications made in the fourth quarter decreased payments.

And reducing payments leads to fewer redefaults. Only 23% of borrowers whose monthly tabs were lowered by more than 10% in the third quarter had fallen behind in their payments within six months, according to the Office of the Comptroller of the Currency and the Office of Thrift Supervision.

This compares with 46% of borrowers whose payments rose by more than 10% and 51% whose payments were unchanged.

"In stressful economic times, modifications that increase monthly payments or keep them the same are likely to run the risk of unacceptably high redefault rates," said Comptroller of the Currency John Dugan.

There are two main reasons for the disconnect between what seems like common sense and servicers' early response.

When the mortgage meltdown first started in 2007, servicers approached loan modifications in the typical way -- tacking on missed payments and penalties to the principal, which increased the monthly tab.

Also, servicers were constrained by contracts with investors who bought mortgage-backed securities, said Joseph Evers, deputy comptroller for large banks.

As foreclosures soared, however, servicers and investors grew more open to lowering payments, as long as it was more cost effective than foreclosing on the home.

"This crisis is more severe," Evers said. "The traditional approach of loss mitigation may not be the right approach in this environment."

Focusing on redefaults

The regulators created a stir in December when they reported that more than 50% of modified mortgages were delinquent six months later. Modification advocates -- including Federal Deposit Insurance Corp. Chair Sheila Bair -- blasted the study for not detailing the how the mortgages were modified.

The Obama administration, financial institutions and housing counselors are counting on loan modifications to pull the nation out of the mortgage crisis. They are at the center of the president's housing plan, which he announced in February.

The program subsidizes interest rate reductions so that borrowers' payments are no more than 31% of their gross monthly income. Many large servicers -- as well as mortgage financiers Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) -- have implemented initiatives in recent months that tie modifications to affordability.

But modifications' effectiveness in reducing foreclosures in the long run remains to be seen. That's why redefault rates are being so closely monitored.

In reviewing banks' fourth-quarter modification efforts, the regulators asked about the types of modifications being done. They found that by year's end institutions were doing many more modifications that lowered payments, rather than leaving them unchanged or raising them.

Some 50.7% of modifications in the fourth quarter decreased payments, compared to 35.7% in the first quarter.

Overall, however, redefault rates are rising. Some 43% of loans modified in the third quarter were at least 60 days delinquent after five months, compared with 37.6% of second-quarter adjustments and 31.4% of first-quarter efforts.

Regulators to banks: remember affordability

The report has spurred regulators to push financial institutions to take affordability into account when doing modifications.

"We have gone back to each of the servicers and directed them to review their modification polices to ensure they are designed to produce sustainable mortgages," Dugan said.

Some servicers, however, are still complaining about the constraints placed on them by investors' contracts.

"That's something they'll have to work through with their investors," Evers said.

The study also raised new concerns about how soon the housing market would recover. The percentage of seriously delinquent prime loans -- held by borrowers with the strongest credit backgrounds -- grew to a record 2.4% at the end of the fourth quarter. This is up from 1.11% at the end of the first quarter.

Regulators are monitoring these figures, since the prime mortgages are considered the lowest risk and account for two-thirds of all loans in the study.

"We watch that very carefully because to the extent we see problems there, it affects a much wider swath of mortgages outstanding in the United States," Dugan said of prime mortgages. "Historically, that's the highest we've ever seen prime mortgages." To top of page

Features
They're hiring!These Fortune 100 employers have at least 350 openings each. What are they looking for in a new hire? More
If the Fortune 500 were a country...It would be the world's second-biggest economy. See how big companies' sales stack up against GDP over the past decade. More
Sponsored By:
More Galleries
10 of the most luxurious airline amenity kits When it comes to in-flight pampering, the amenity kits offered by these 10 airlines are the ultimate in luxury More
7 startups that want to improve your mental health From a text therapy platform to apps that push you reminders to breathe, these self-care startups offer help on a daily basis or in times of need. More
5 radical technologies that will change how you get to work From Uber's flying cars to the Hyperloop, these are some of the neatest transportation concepts in the works today. More
Sponsors
Worry about the hackers you don't know 
Crime syndicates and government organizations pose a much greater cyber threat than renegade hacker groups like Anonymous. Play
GE CEO: Bringing jobs back to the U.S. 
Jeff Immelt says the U.S. is a cost competitive market for advanced manufacturing and that GE is bringing jobs back from Mexico. Play
Hamster wheel and wedgie-powered transit 
Red Bull Creation challenges hackers and engineers to invent new modes of transportation. Play

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.