Years ago a lender sent me the most-interesting note. “Peter,” I remember it saying, “because you pay your mortgage in full and on time — and because things sometimes get a little tight — please feel free to skip one mortgage payment during the coming year.”
Given the way most lenders behave you might think that my lender was a little daffy or perhaps a long-lost relative. Not so. Missing mortgage payments is a huge financial no-no, but here was a sane lender saying I could skip a payment and not worry about some penalty. Interest on the payment not made would simply be added to the loan balance.
In effect, the lender was suggesting a mortgage modification. There were no screams about contracts, required payments, late payments, credit dings or lender rights. The lender was just offering a nice option for good customers.
If you look carefully at the offer you can see that the lender also benefited. If we imagine that the lender had 3 million loans and that 50 percent took advantage of the skip-a-payment offer, then we have the equivalent of new loans for 1.5 million months. Divide that number by 120 (as in 120 months or 10 years, about the length of time many loans are actually outstanding) and the lender instantly originated the equivalent of 12,500 mortgages for the cost of postage and printing.
You could also look at the lender’s offer from another perspective. The interest not paid for a month was added to the principal balance, meaning the borrower owed more and would have somewhat larger interest costs each month until the entire mortgage was repaid.
I always thought the lender in this case was smart because the skip-a-payment offer was good for both the lender and those borrowers who wanted such an option. Also, there wasn’t much risk for the lender, just one monthly mortgage payment from borrowers with proven payment histories.
The New World of Modifications
Since the real estate crisis first became apparent there have been unending calls for loan modifications, workout programs and payment plans. The presumption has always been that such efforts could reduce the scope of the foreclosure crisis, but now there’s evidence that such programs are failing and with them hopes for a quick return to steady home values.
The much-touted federal Home Saver Advance (HSA) program is seen as a last lifeline for many borrowers, yet just 30 percent of those in the program continue to make full and timely payments. As the government has just reported, the plan “is showing high re-default rates on the early offerings. Performance on the February through April offerings shows a re-default rate of almost 70 percent, which calls into question the program’s assumption that borrowers have the capacity to make payments going forward.”
The private sector may be doing better or it may be doing worse — it’s hard to know because complete numbers are unavailable. To understand why the figures are so muddled you have to take a look at the best information we have, a study released by the Treasury Department in April.
The study — the OCC and OTS Mortgage Metrics Report, Fourth Quarter 2008 — covers more than 34.7 million first lien mortgage loans. However, the report is especially notable for what it doesn’t say: First, it relates only to first liens when the reality is that lenders with second liens can also foreclose — think about the millions of “piggy-back” loans made during the past few years. Second, results from payment plans are not disclosed.
The Definition Game
Mortgage workouts are generally divided into two categories, loan modifications and payment plans.
A loan “modification” describes a situation where the lender and borrower agree to new terms, say a lower interest rate or a longer term or both. A “payment plan” is usually an arrangement where the interest rate and loan term do not change, instead the borrower is given the opportunity to make up missed payments.
In the government report, however, payment plans are defined to “include loans that are in a trial periods with respect to making revised payments under a proposed loan modifications. The loans are reported as modifications after successful completion of the trial periods.”
Translation: Payment plans that are not successful are not reported.
It’s important to show payment plan results because most loan changes are actually payment plans rather than modifications. The government says that in the fourth quarter of 2008 there were 121,496 loan modifications — and 180,152 workout plans.
It’s easy to see that with a workout plan a borrower may well face higher monthly payments. For instance, Towson misses a $1,000 monthly payment and the lender says rather than foreclose we can just have a workout plan: Pay back the missing money during the coming year and that’s the end of the problem.
Sounds great, except now homeowner Towson owes $1,083.33 per month — that’s $1,000 for the regular loan payment plus $88.33 ($1,000 divided by 12) to make up the missing payment.
Federal figures show that in the last quarter of 2008 more than a third of loan modifications (37.2 percent) resulted in payments that were at least 10 percent lower while 13.5 percent of all borrowers saw smaller payment declines. Amazingly though, 23.9 percent saw no change in payment amounts while 25.3 percent saw monthly costs rise!
The results are pretty much what you would expect: 58.3 percent of all modified loans re-default after 30 days — and this is AFTER many borrowers completed test periods with new rates and terms.
And what about payment plans, programs where monthly costs rise in virtually all cases? The government does not provide re-default figures for payment plans but the failure rate must be huge if only because most participating borrowers face higher monthly costs.
“Loan workouts of some kind are seen as a last resort by many troubled homeowners,” says James J. Saccacio, chief executive officer of RealtyTrac.com, the nation’s leading source of foreclosure listings and data. “However, it’s clear that modification programs and workout plans are not producing the results everyone wants. For this reason, new ideas need to be considered and they need to be considered as quickly as possible to reduce the rising number of foreclosures we are seeing nationwide.”
Cause & Effect
The numbers we have from the government suggest that loan modification efforts should continue for two reasons: First, some percentage of borrowers are succeeding and that’s great news. Second, even when borrowers do not succeed their homes are off the market for several months, meaning that their properties are not being added to the inventory of unsold bank-owned properties that’s now pressing-down home values.
The numbers also raise a question: Maybe we need something like the skip-a-payment plan offered long ago by my lender?
The deal could work like this: You get a one-time right to skip one monthly payment for each year of good performance. If you have owned a home and made full and timely payment for five years, you could opt to miss as many as five payments — they would simply be added to the end of the loan and repaid when the property was sold. Because the skip-a-payment plan is only allowed once, it would be smart to only use it in the event of a significant emergency.
In this situation there would be no credit damage, no foreclosure notices and no write-downs on lender books. In fact, lenders would actually see an increase in loan volume as borrowers opted to skip payments and loan balance rose. Fewer distressed homes would come onto the market, the homes which push down local housing values. Borrowers with temporary financial problems, say those out of work for a few months, would not lose their homes, communities would not lose their property taxes and neighborhoods would not be dotted with abandoned houses.
There are surely risks to this idea. For instance, borrowers who lose jobs may never be able to regain their financial strength. Lender cash flow would be impacted.
But we already have a situation where borrowers are losing homes and lenders are losing money. The patch-and-repair mortgage modification plans to date have not produced the level of success anyone would like to see. The skip-a-payment concept would not make the situation worse and it might make matters better for many borrowers and lenders. In the present financial climate, that’s not much of a risk.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.