Do Mortgage Modifications Stick?

As Washington policymakers bat around proposals to tackle the housing crisis more directly, a forthcoming report from federal banking regulators will offer some sobering statistics: Many mortgages modified by lenders to prevent foreclosures wind up in default anyway.

The report isn’t expected out until next week, but Comptroller of the Currency John Dugan said in his remarks to a housing conference that it will show that more than a third of mortgages modified in the first half of the year were in default within three months; more than half were in default within six months. (See the OCC’s chart.)

Those are sobering stats, and raise questions about the merits of various proposals to use government resources to subsidize foreclosure-prevention efforts. But there are also some distinct caveats to the data, which were promptly pointed out at the same gathering by Sheila Bair, the Federal Deposit Insurance Corp.’s chairman and perhaps the most visible advocate of government-led foreclosure mitigation.

The OCC and OTS Mortgage Metrics Report, launched this year by the Comptroller's office and the Office of Thrift Supervision, pulls data from big banks and thrifts that account for perhaps 60% of first mortgages. This will be the first of the reports to look at loan modification data directly.

Not all borrowers who default -- ie, miss payments -- wind up seeing their homes go into foreclosure, however, something Dugan noted. And Bair warned that the numbers have other limitations for policymakers as well, something Dugan acknowledged.

For example, it's not clear just what a mortgage modification means when it comes to the new data. Fannie Mae and Freddie Mac, following a protocol similar to one the FDIC developed after it put IndyMac into receivership, use a combination of interest-rate reductions, loan-term extensions and principal forbearance (essentially tacking a portion of the principal on to the end of a loan, where it doesn't accrue interest). But private-sector lenders and servicers have a variety of other modifications, some of which are less substantial.

"We really don't know if it was a meaningful payment reduction," Bair said. She mentioned a Credit Suisse study citing a much lower default rate for loans with interest-rate reductions.

Bair also noted that her proposal (toward the end of her Nov. 18 testimony) to use government funds to prevent foreclosure offers a federal loan guarantee that kicks in only if the homeowner has remained current on the modified loan for six months. It also would reduce monthly payments to 31% of the homeowner's gross income, making it more likely that the payment would be affordable, she has said.

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