For the past two years foreclosure activity has been in decline. According to RealtyTrac, foreclosure filings fell 29 percent in 2011 and 15 percent in 2012. But while we're seeing fewer foreclosures, some properties which were once thought to be saved are again facing the auction block — a problem generally known as “re-default.”
The Treasury Department says that as of November more than 1.1 million homeowners had received “permanent” mortgage modifications through the Home Affordable Modification Program (HAMP). The typical modified loan meant savings of $544 a month, a big number for most households.
The catch is that many of the modifications are anything but “permanent.” In many cases modifications are simply a pit stop on the road to foreclosure.
In 2010, Fitch Ratings projected that as many as 75 percent of all subprime and Alt-A loan modifications would re-default again within a year. Essentially, these were toxic loans such as option ARMs and interest-only loans as well as mortgages created with little documentation.
The 2010 prediction was better for prime loans, for such financing between 55 and 65 percent of all modifications were expected to slide back into default according to Fitch.
Modification critics will cite the re-defaults as evidence that federal programs to help distressed borrowers fundamentally don’t work. In fact, what the re-defaults show is that without the government’s Making Home Affordable effort foreclosure numbers would be far worse than they are today — and that would mean lower home values and a slower housing recovery, assuming that by now we would even have a recovery.
To understand why first consider that virtually every home which is a candidate for modification would otherwise be foreclosed. The miracle is not that re-default rates are high; it’s that many homes have been saved.
But what about today?
Diane Pendley, the Managing Director with the Operational Risk Group at Fitch Ratings, told us that the re-default picture is changing.
First, we have to view loans the way we view wine; we have to look at the vintage. The 2010 analysis was based on modifications made in the first quarter of 2009 for loans with 12 months of seasoning, loans that were a year old. Today, 48 months later, those same modifications have re-default rates in the range of 85 percent to 90 percent, according to Pendley.
Second, things have gotten better. Later modifications, says Pendley, such as “those made in early 2011, show improved performance with average re-defaults after 12 months running 40 percent to 45 percent.”
Why the better results with more recent loans? Pendley says the answer includes larger payment reductions, smaller claims against borrowers for unmade payments, plus more principal forgiveness.
The real problem we're having is not re-defaults; it’s that the toxic loans now being modified should never have been originated in the first place. The evidence can be seen not only in the massive number of loans which have failed since 2006, but also with the huge awards paid by lenders to settle claims from mortgage investors and insurers that required loan standards were not made in the first place.
From this point forward one can expect that re-default activity will generally decline as home values rise, the economy stabilizes, short sales increase, principal write-downs grow and the final rules under Dodd-Frank block any return to toxic mortgages.
As of late December, Pendley says the percent of subprime loans having received at least two modifications was approximately 55 percent. The last of the toxic loans are being scrubbed from the system and as that happens re-default rates will keep dropping.
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