Rising Redefaults Are Raising Loan Mod Mandate Odds
Washington-The last chance for servicers to voluntarily modify mortgages may be at hand.
For the past year and a half, the government has pressed for modifications and set incentives for them - but has stopped short of forcing them. Though servicers have pledged to improve their efforts, progress has been slow, and many still refuse to modify loans in ways that lead to lower payments for the borrower.
The result is a wave of redefaults and increasing evidence that public and private efforts to stop the foreclosure crisis have failed.
Observers say if changes being pressed by the Obama administration cannot improve the situation, Congress or regulators are likely to take more drastic action, including a renewed push for legislation to allow judges to rework loans in bankruptcy.
"If modifications don't pick up, I think mortgage bankruptcy returns with a vengeance," said Jaret Seiberg, a policy analyst with Washington Research Group. "Bankruptcy is the tool that the government can use to modify contract terms without incurring liability. If we enter the fall, and we've helped hundreds of people rather than tens of thousands, there's going to be tremendous pressure to pass full-scale mortgage bankruptcy. So there's a lot riding on the implementation of the mortgage modification plan."
The bankruptcy reform bill failed a critical vote in the Senate last week after negotiations with the industry broke down, but several policymakers have vowed to return to the issue.
The Obama plan remains the best chance yet, many said, to stem the tide of foreclosures, in part because it would force servicers - at least the ones who volunteer for the program - to do what many have avoided so far: lower borrowers' monthly payments.
Up to now, modifications performed by a large portion of the industry have redefaulted at a rate of around 50%. But many of those modifications did not actually address the borrower's ability to pay the loan.
A lot of the modifications are repayment plans," said Mark Zandi, chief economist and co-founder of Moody's Economy.com Inc. "They're not reducing the monthly payment or the principle amount. They're really not providing any relief to the distressed homeowner, and that's just not going to work."
Observers say the government's latest approach could effectively force servicers to lower borrowers' monthly payments and close the gap between the current value of a home and the outstanding loan.
Under the Obama plan, servicers that volunteer - of which 12 have to date, accounting for roughly 75% of outstanding mortgages - would be required to lower borrowers' monthly debt-to-income ratios to 31%.
Tougher modification standards could translate into a lower redefault rate. Mortgages owned by IndyMac and modified through the Federal Deposit Insurance Corp.'s plan, which required borrowers DTI ratios to be lowered to at least 38%, are showing a redefault rate of just 12%, according to the FDIC's latest data, released at the end of March.
Other changes announced last week would require participating servicers of second mortgages to do matching modifications on those second loans, which could mean an even sharper reduction in some borrowers' monthly payments.
"This plan at least restores the notion of lien priority at some level," said Pete Mills, who is a consultant to Potomac Partners and a former lobbyist for Countrywide Financial.
"Because of the precarious position of the second-lien holder, I think this will in general be a positive move forward, but it's not going to be a slam dunk.
"I think there will be some hiccups along the way."
Industry participants also said the specific requirements for modifications under the administration's plan would prevent servicers from performing the more halfhearted versions of old.