Mortgage servicers currently hold 6 million modified mortgage loans, according to data from National Mortgage News.
The resets, which return loans to their pre-modification rates and terms, will begin as early as 2014.
Data from the Department of Treasury show resets will require once-financially strapped borrowers to come up with a higher mortgage payment, in some cases, up to $302 a month more over the term of the reset.
The potential payment shock brought on by increased mortgage payments could trigger a significant wave of redefaults for some servicers. It is a potentially sizable portfolio. Overall estimations based on data in SIGTARP’s July 2013 Quarterly Report to Congress show the industry has approximately $400 to $500 billion in mortgage loan modification balances at risk of redefaulting.
Economic conditions combined with reset terms could lead to high redefault rates.
Many people hit hard by the financial crisis who received a loan modification still may be struggling to regain their economic footing and lack the resources to quickly recover from financial setbacks. The additional payment shock possibly created by mortgage interest rate resets has the potential to send a large portion of distressed borrowers into redefault.
Ongoing, elevated unemployment levels, spikes in consumer borrowing, and high debt-to-income ratios are all contributing to their financial fragility, compounding the impact that increased mortgage payments could have on this borrower base.
There may also be a contingent of borrowers who have done little to proactively improve their financial standing. Servicers will need to determine—based on regulatory guidelines and investor rules—whether it makes sense to offer additional concessions to those who haven’t made improvements after a five-year rehabilitation period.
Mortgage loans aren’t recovering as quickly as other products from their default highs in 2010. Combined with the historical 46% redefault rate on HAMP loan modifications, according to the SIGTARP report, this statistic reinforces the need for redefault mitigation efforts.
A four-step approach to redefault prevention:
Preventing or limiting losses from loan modification resets is a potentially attainable goal. But the unique characteristics of loan modifications require a different approach than the traditional default prevention methods used for non-modified loans. Part of this approach will involve some tough decisions.
For instance, today’s changing economic and market dynamics, such as increasing home values, may cause some investors and servicers to evaluate whether to offer retention options or move a property toward liquidation.
To protect your assets, mitigate risk, and best serve your borrower base, we recommend the following four-steps be considered:
1. Size the impact to your organization with a borrower-level risk-assessment model
2. Create treatment strategies to prevent losses and help drive stability in the underlying market
3. Prepare to take an enterprise-wide approach
4. Focus on fair treatment of borrowers and consumer protection standards
Developing a documented approach:
Whether your portfolio consists of HAMP modifications, government-sponsored enterprise modifications, private modifications, or all, the following four steps may make a difference to your business, your investors, and your borrowers:
1. Develop a borrower risk assessment model
2. Create treatment strategies based on borrower risk scores
3. Take an enterprise-wide approach across all areas of servicing
4. Place a strong focus on fair treatment and consumer protection standards
The upcoming modification resets, combined with cautious economic statistics, are a potential warning sign for the mortgage servicing industry. Taking action now with a redefault prevention strategy that specifically targets loan modification resets could help prevent costly redefaults and allow for continued improvement and stabilization in the housing market.
Implementing a strategy for loan modifications is not only a smart move; it’s a timely one that could begin paying off in 2014. And it could give your organization an advantage in a tightly competitive marketplace.
Martin Touhey, principal, and Carlos Brunet, senior manager, are part of the Consumer Finance Group at PwC.