Fitch: More than 60% of Mods Likely to Re-Default

Despite an increasing willingness among lenders to forgive a portion of the principal balance on loan modifications, Fitch Ratings predicts that 60% to 70% will still re-default within one year. The "aggressive" use of streamlined modification without income verification is one factor behind Fitch's gloomy prediction. Rising unemployment and continuing home price declines also will undermine efforts to keep troubled borrowers in their homes, the rating agency said. Initial data does not suggest that principal reduction alone has much impact on re-default rates, according to Fitch. The rating agency found that even with principal forgiveness of 20% or more of the loan amount, 28% of loans re-defaulted within six months. That compares to a 30% re-default rate on loans where the outstanding principal increased on a modification due to the capitalization of past due interest and other costs. By contrast, Fitch said modifications that reduce the borrower's monthly payment do appear to reduce the re-default rate. Reducing the borrower's payment by 20% or more lowered the six-month re-default rate to 21%. That compares to a 49% re-default rate for modifications where the monthly payment increased by 10% or more due to the capitalization of arrears. Fitch recommends that servicers focus on a borrower's cash flow and payment-to-income ratio in fashioning loan mods. "Some combination of payment reduction and either principal forbearance or forgiveness may be the most effective approach to mortgage modification as it may increase borrower's ability and willingness to repay the modified amounts," Diane Pendley, a managing director and head of Fitch's operational risk group, said in a press release.