After a bruising 2007, a year which saw massive numbers of foreclosures, widespread real estate price declines and mammoth losses on Wall Street, it seems as if 2008 is starting off with some good news on the real estate front:
Hope Now, the volunteer effort announced by President Bush in late August, says the mortgage industry “assisted 370,000 homeowners during the second half of 2007. This includes 250,000 formal repayment plans and 120,000 modifications.”
The Mortgage Bankers Association reports that “the mortgage industry modified an estimated 54,000 loans and established formal repayment plans with another 183,000 borrowers during the third quarter of 2007.”
Countrywide Financial Corporation said “it helped more than 80,000 borrowers retain their homes in 2007.”
By any standard, every home saved from foreclosure should be seen as good news — borrowers get to keep their property, lenders avoid costly foreclosure actions and there’s less downward pressure on neighborhood home values. Lenders, for their part, deserve credit for such foreclosure prevention efforts as they have undertaken.
That said, the numbers above do not tell the entire story.
In an ideal world it would be wonderful to suggest that all loan modifications and repayment plans keep borrowers away from foreclosures and the courthouse steps. Indeed, many news stories equate the numbers above with homes saved from foreclosure. Unfortunately, the grim reality is that while modifications and repayment plans can help many borrowers, a large percentage of those enrolled in such programs will lose their property.
“Many borrowers with whom lenders establish a loan repayment plan or modification cannot live up to the modified terms,” says the Mortgage Bankers Association.
In general terms, a “loan modification” can be seen as a situation where contract interest rates or other mortgage features have been changed by a lender in an effort to accommodate a distressed borrower. A repayment plan, says the Mortgage Bankers Association, usually involves a situation where “a borrower would agree to a plan whereby any delinquent payments will be spread over some period of time. The borrower is expected to remain current and make the additional required payments.”
If some percentage of borrowers fail even with help from lenders, then to judge lender efforts it becomes important to ask just how many homes are lost even with loan modifications and repayment plans.
Published percentages are murky because not all commentators use the same data or time frames, however a number of “re-default” estimates are available:
“Roughly 50 percent of loan modifications end up defaulting at some point anyway. Any loan modification plan can add stability to the market, but it cannot fix a stressed-out borrower in an overvalued home,” says Paul J. Miller (no relation), an analyst with the brokerage firm of Friedman, Billings, Ramsey.
“If a 2/28 or 3/27 hybrid ARM loan is modified, it is uncertain in our view, based on limited recidivism rate (or re-default rate) data, whether the borrower will benefit from the loan modification,” says Standard & Poors.
The Wall Street Journal reports that “Kevin Kanouff, president of Clayton Fixed Income Services, the surveillance group for Clayton Holdings, which oversees outstanding mortgage-backed securities, says subprime borrowers with adjustable-rate mortgages who have their loans restructured tend to default in a range of 40 percent to 50 percent.”
In a report from June 2007, Fitch Ratings said that “servicers who had the most experience with loan modifications indicated the re-default rate for modifications has been in the 35 percent – 40 percent range, based on an admittedly small number of modifications completed to date. However, most servicers indicated they expect that this re-default rate could increase, again due to current market conditions.”
“Numbers regarding loan modifications and repayment plans may be nothing more than statistical sleight of hand,” says James J. Saccacio, chief executive officer of RealtyTrac.com, the nation’s leading foreclosure marketplace. “A large number of borrowers in such programs will unfortunately fail, meaning that they will sooner or later be foreclosed, neighborhood home prices will be impacted and lender asset values will be reduced.”
“Loan modifications and repayment plans in too many cases may have the effect of merely delaying foreclosure actions,” Sacaccio continued. “As a result, reported foreclosure figures will be temporarily reduced and lender books will not properly reflect the true performance of loan portfolios. Investors calmed by modification and repayment reports may be surprised by lender results down the road.”
Figures from the Mortgage Bankers Association show that re-defaults are a significant problem for both lenders and borrowers.
Nationwide, says the MBA, 29 percent of all borrowers facing foreclosure in the third quarter of 2007 had defaulted on a previous repayment plan. Among subprime ARM borrowers the figure is even more grim: 40 percent had participated in repayment plans and failed.
Off The Books
Why do loan modifications and repayment plans fail with such frequency?
With a loan modification there’s an effort to reduce borrower costs by stretching the mortgage term or reducing the interest rate for a given period. However, even though loan terms are changed the borrower may still lack the financial capacity needed to meet the new requirements because of illness, the loss of a job, divorce or the death of a spouse.
With a loan repayment plan the concern is different: In this situation a borrower has typically fallen behind on the mortgage. Rather than call the loan, the lender instead allows the borrower to make up the missing payments over several months. The borrower is then in the position of making regular monthly payments as well as additional amounts to cover the payments which were not made. In other words, rather than declining, under the terms of many repayment plans borrowers actually face higher costs.
One way to reduce repayment plan expenses is to stretch the repayment term and this is exactly what’s happening. Repayment plans, says Fitch Ratings, “have typically been 3-6 months; however, servicers have reported that plans are trending longer, so servicers are now establishing extended periods, in some cases as much as 12-24 months. The longer time frames allow borrowers to reinstate, even when they have limited funds, by reducing the amount of additional monthly outlay.”
The Risks of Excess Re-default
As bad as the consequences of default might be, the consequences of a “re-default” may actually be worse for borrowers, lenders and investors.
Lenders: Because delinquent loans are outstanding longer, lender records can show larger debts and thus bigger losses if loans re-default. “If a borrower re-defaults on the modified loan, losses to the holders of rated securities may be greater than if the loan was liquidated instead of being modified,” says Standard & Poors.
Borrowers: When foreclosure prevention efforts do not succeed, it means that debt to the lender can be larger than might otherwise be the case because there have been additional missed payments.
Investors: Published reports may not adequately reflect the risk of loss since borrowers may not be considered “at risk” of default during the time when a repayment plan or loan modification is in effect. The result is that loan portfolios may be overvalued in the absence of better information.
Columnist Peter G. Miller is the author of The Common-Sense Mortgage and is syndicated in more than 100 newspapers.