There’s a new word which is beginning to cloud the foreclosure debate, the term “re-default.” No longer do we have people facing foreclosure just once, instead we have large numbers of borrowers entering foreclosure multiple times on the same loan.
Given the terrible consequences of foreclosures it seems hard to believe that re-defaults are common and yet it’s likely that more than a million homeowners have re-defaulted during the past year.
How It Works
A growing number of lenders have promised to modify toxic loans. As examples, both JPMorgan Chase and Countrywide have said they each expect to modify 400,000 mortgages. HOPE NOW says “approximately 1.7 million foreclosures have been prevented by the mortgage lending industry in the first 10 months of 2008.”
Not only does HOPE NOW say that a lot of foreclosures have been prevented, it also says that prevention levels are rising:
“In October, mortgage servicers helped prevent foreclosures by completing 225,000 mortgage workouts, which include both modifications to the terms of existing mortgages and payment plans. Barring an unforeseen life event such as a job loss, death, or illness, all workouts are intended to enable a homeowner to remain in his or her home as long as he or she wishes to do so.”
This all sounds pretty good, except for several very large and very visible problems: Despite the HOPE NOW numbers and the efforts of private-sector lenders in general, foreclosure levels are rising and a majority of workouts do little more than postpone trips to the auction block.
A False Top
Figures from RealtyTrac show that for the month of November there were 259,085 foreclosure filings — up 28 percent from a year ago. Not only are foreclosure numbers up, they’re huge: As the Mortgage Bankers Association says “the percentage of loans in the process of foreclosure set a new record” in the third quarter.
“Rising workout numbers have had a major impact on the foreclosure debate,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the country’s largest marketplace for foreclosure properties. “Because of loan workouts and foreclosure moratoriums, what we’re measuring today is not what we measured a year ago. Loan workouts and moratoriums are distorting the numbers, shrinking apparent foreclosure levels and hiding the full extent of the problem.”
The Workout System
During the past year two forms of workout programs have emerged: those from the private sector and those which have been created by government action.
Lender workouts in the private sector generally come in the form of “modifications” and “payment plans.” In general terms, a modification is any change in the mortgage contract, say an interest rate reduction for six months, while a payment plan is a restructuring of the debt, such as allowing a borrower to make up a missed payment over a period of months or years.
Mortgage investors are largely opposed to loan modifications and with reason. Imagine that you bought a package of loans. The cash you pay for such an investment is determined by the value of the interest you expect to receive. For instance you might pay $1 million for a package of loans yielding 6 percent interest but only $975,000 if the package paid out 5.75 percent.
With a mortgage modification, loan terms are being changed and borrowers are paying less. For investors, a smaller income means not only get less cash each year but that the market value of the package has fallen because the yield has been reduced.
Unlike loan modifications, payment plans shift costs and liabilities to the borrower. Suppose you have a mortgage with a $1,500 monthly payment and imagine that you can’t pay in December. The lender doesn’t want to foreclose so instead offers a payment plan: You won’t be foreclosed if you pay back the missing money over the course of a year.
This sounds like good news for the borrower and for some borrowers a payment plan can save a home from foreclosure. The catch is that payment plans don’t work for a large percentage of borrowers and here’s why: Go back to that missing $1,500. If you have to repay it during the next year it means your mortgage payment increases by $125 per month. Instead of paying $1,500 you now need to come up with $1,625.
The Re-default Gap
As a matter of logic we know that some percentage of loan workouts fail, but the real question is this: How many? Here are the figures for the first quarter of 2008:
“After three months,” says John C. Dugan, the Comptroller of the Currency, “nearly 36 percent of the borrowers had re-defaulted by being more than 30 days past due. After six months, the rate was nearly 53 percent, and after eight months, 58 percent,”
Dugan’s numbers are not plucked from the air. Instead they are part of a soon-to-be-released study which looks at 35 million mortgages, home loans worth more than $6 trillion.
What the Dugan percentages mean is that a very large number of mortgage workouts simply postpone foreclosure actions and thus reduce foreclosure reports. For example, if 36 percent of the 225,000 workouts reported by HOPE NOW were to fail in a month, it would mean that October foreclosure figures had been undercounted by at least 81,000 homes. If 58 percent of the reported workouts re-default after eight months then 130,500 properties that were temporarily saved from foreclosure will now be lost.
While the Dugan numbers give us a better sense of just how many loans are distressed, the Comptroller’s numbers themselves understate the foreclosure problem.
Huh? How is that possible?
Dugan’s numbers only reflect re-default levels for loan modifications, workouts where borrower costs are more likely to fall, at least on a temporary basis. What he is NOT counting are payment plans, arrangements where borrower payments are likely to rise and thus should have even more failures than modifications.
As Dugan explains, “when I refer to ‘loan modifications,’ I am excluding so-called ‘payment plans,’ which are a less aggressive form of loss mitigation.”
By The Numbers
Because of loan workouts we can expect that a large number of November’s foreclosure totals will include homes that should have been counted in October. The October late count will be offset by more deferrals in November, thus we have a process which continually holds down reportable foreclosure actions.
The situation is further clouded by the reality that we don’t know how many borrowers have had multiple re-defaults. These are homeowners who have faced foreclosure, entered into a workout, failed after a few weeks or months and were then enrolled in a second workout plan or even a third or a fourth. In effect, such borrowers may account for a disproportionate number of the homeowners who have been “saved” from foreclosure.
In a number of states the time required to foreclose has been extended by state rules and regulations. In Maryland, for example, the foreclosure process was increased by at least 135 days because of new rules which went into effect last April.
Mandated foreclosure delays are increasingly common; such legislation has been enacted in California, Massachusetts, New York and North Carolina, and more states are considering similar moratoriums. At the federal level, Fannie Mae and Freddie Mac — now operating under a federal conservatorship — have prohibited foreclosures between November 26, 2008 and January 9, 2009.
Government actions to delay foreclosures are good news for borrowers but bad news for investors. One key problem with foreclosure moratoriums is that borrowers resigned to failure can con the system — knowing that they won’t be foreclosed they simply make no payments for months on end.
Foreclosure moratoriums also hold down foreclosure actions and thus hide the true magnitude of the toxic loan problem.
Does it matter that foreclosure actions are being delayed? Yes. Public perceptions and public policy hinge on accurate data. Short-term workouts, unsuccessful workouts, multiple workouts and moratoriums all cloud the real extent of the foreclosure problem — and thus the steps which may be necessary to reduce damages.