"It's the housing market, stupid." That's what an increasing number of policymakers and economists are saying as they push for widespread mortgage modifications as a way to address a root cause of the financial crisis. With more than 1.5 million houses in foreclosure (three times the normal rate) and about 3.5 million other homeowners behind on mortgage payments, the idea of rewriting loan terms has broad appeal. As advocates contend, homeowners will keep their houses, and lenders as well as investors in mortgage-related securities will recoup more money than is typically netted in a foreclosure. As a bonus, property prices across the country may stabilize more quickly as fewer foreclosures weigh on the market.
In fact, mortgage lenders are jumping on the bandwagon. There were 79,000 such modifications in August, up 200% from a year ago, according to the industry-backed Hope Now Alliance.
There is little evidence, however, that they will succeed in the long run. In fact, most studies of what happens after loans are modified show that a big percentage wind up in default anyway. In one such study, the ratings agency Moody's looked at a group of subprime adjustable-rate mortgages modified in the first half of 2007. It found that by March 2008, only a third were either still current or had been fully paid off.
Consumer groups argue that part of the redefault problem is lenders' reluctance to make the sorts of changes that will really improve a homeowner's chances. While the popular notion of loan modification might have the lender lowering an interest rate or reducing the overall loan balance, many work quite differently. For example, one of the most widely implemented changes is to simply spread missed payments over the remaining life of the loan. That has the perverse effect of raising, not lowering, a homeowner's monthly payment. The nonprofit Center for Responsible Lending estimates that nearly half of the loan modifications reported by Hope Now Alliance have left homeowners with the same or higher monthly payments.
Not surprisingly, modifications that result in stressed homeowners paying more each month have a greater chance of winding up in default or foreclosure. A recent Credit Suisse report looked at modifications made to subprime loans in the last quarter of 2007 and found that 44% of loans with increased monthly payments were more than 60 days delinquent within eight months. What had a much better shot of working: reducing interest rates and principal. Only 15% of loans that had received an interest-rate reduction and 23% in which the principal balance had been reduced were more than 60 days delinquent after eight months.
But ultimately, even lenders' best efforts might be crippled by a harsh reality: plenty of homeowners are never going to be able to pay for their houses, no matter how generous the terms, because someone the homeowner, the mortgage broker lied about or simply ignored income and assets. Cena Valladolid, chief operating officer for Consumer Credit Counseling Service of Southern Nevada, says more than half of the homeowners who seek help from her nonprofit are living in houses they never had a realistic shot of affording. The best advice she can offer in the depressed Las Vegas real estate market is to ask the lender to allow a short sale, so that the house might be sold for less than what's owed on the mortgage.
What's clear is that many homeowners are in the midst of an intense financial crisis. In a September 2008 survey by Campbell Communications, an outfit that works with the mortgage industry, property taxes were the third most cited reason people thought they might stop making mortgage payments, illustrating that the financial pressures on overwhelmed homeowners go far beyond the terms of their loans. "Many of the people who bought homes were not prepared to be homeowners," says survey designer Tom Popik. And all the loan modifications in the world can't change that.