Why the Loan-Modification Program Isn't Working

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Marcio Jose Sanchez / AP

Homeowners listen to a counselor at the Cow Palace in Daly City, Calif., on Oct. 16, 2009. Thousands of homeowners turned out to the event, which was sponsored by Neighborhood Assistance Corporation of America, a Boston-based nonprofit that strives to help people restructure high-risk loans

The Obama Administration is gearing up to play hardball with mortgage companies that only temporarily lower struggling homeowners' monthly payments. But as the drive to make more loan modifications permanent kicks off, there's a weightier question to ask: Can the government's $50 billion foreclosure-prevention initiative deal with the crisis as it now exists?

The problem the Administration is out to tackle is related to the structure of the Home Affordable Modification Program (HAMP). The first three months of a mortgage rewrite are something of a probation period— and very few homeowners are making it out of that trial. More than 650,000 borrowers have been placed in trial modifications, but as of September, fewer than 2,000 had become permanent.

On Nov. 30, the departments of Treasury and Housing and Urban Development announced that they would no longer take kindly to mortgage firms that don't make modifications lasting. Teams of officials are headed to the nation's largest lenders for a closer look at what's going on, and starting in December public progress reports will include the number of loans being converted to permanent status — an attempt to shame the firms into quicker action. Monetary penalties could follow.

For all the effort being spent on whipping companies into shape, though, there is much less energy going toward addressing the changing nature of foreclosure. HAMP was crafted to deal with the effects of the housing bubble: excessively easy credit let people buy homes they couldn't really afford and often with loans that carried spiking interest rates and payments.

The major difficulty now is the weak economy and rising joblessness. Under the U.S. government's plan, a modified loan payment must not account for more than 31% of a family's income. With unemployment north of 10%, in a growing number of cases, the mortgage isn't the problem — the lack of a paycheck is. "It increasingly appears that HAMP is targeted at the housing crisis as it existed six months ago, rather than as it exists right now," concluded the Congressional Oversight Panel, a group charged with evaluating the program, in an October report.

That's not to say there aren't real issues with how trial modifications are (or aren't) being converted into permanent ones. Housing counselors report that while loan servicers have made progress in certain areas — phone-wait times that used to run up to an hour now might last only 15 minutes — there are still major bottlenecks in getting the final sign-off for a permanent modification. And borrowers are not without fault. Some 375,000 homeowners should be eligible for permanent modifications by the end of the year, according to the Treasury Department, but some 20% of them haven't provided any of the documentation necessary to complete the process, and twice as many have parts of their paperwork missing.

Still, the larger storm cloud on the horizon is the state of the jobs market. While an out-of-work person can, theoretically, get a loan modification under HAMP by proving eligibility for at least nine months of unemployment benefits, the program isn't set up to handle someone without a regular stream of income.

Elsewhere, such programs do exist. For example, under the auspices of the Homeowners' Emergency Mortgage Assistance Program, Pennsylvania will loan its residents up to $60,000 over the course of two years in the wake of life events such as losing a job or falling severely ill. While a homeowner is out of work, the loan is interest-free. In exchange, the state gains a legal right to the house should the owner default on his or her mortgage.

Rising unemployment isn't the only dynamic HAMP fails to thoroughly take into account.

Another is the changing behavior of people who owe more on their mortgage than their house is worth. According to a recent analysis by the credit bureau Experian and the consultancy Oliver Wyman, nearly 600,000 borrowers might have intentionally defaulted on their mortgages in 2008, twice as many as the year before. The social norm that in previous eras would have prevented people from simply walking away from their homes seems to be eroding — but HAMP puts a low priority on reducing the overall amount a person owes. In fact, among permanent modifications, the average loan amount as compared to home price (the so-called loan-to-value ratio) has increased.

The other big gap in HAMP is the way it deals with— or fails to deal with — people who wouldn't be in a position to keep their houses even with a modification. Emily Jones, a manager at Neighborhood Housing Services in Boise, Idaho, says about half of all people who walk into her housing-counseling agency fall into that camp. "The goal isn't to keep the home in every situation," she says. "The goal is to avoid foreclosure, and in a lot of situations, it's not in the client's best interest to try to keep the home and only postpone the inevitable."

And yet the part of HAMP that would most work to help these people has been incredibly slow to get off the ground. Back in May, the Treasury Department announced that it would issue guidelines on how lenders might speed up dealing with borrowers who simply want to hand back the deed to their house or sell their home for less than is owed on the mortgage (a so-called short sale). Distressed homeowners and housing counselors have long complained about short sales being scuttled by lenders that take too long to respond to a potential buyer's offer. The plan to beef up the process for these sales, originally announced in May, wasn't unveiled until Nov. 30 — and doesn't go into effect until April 5, 2010.

Is there harm done in the government's leaning on mortgage companies to make trial modifications permanent? Probably not. But there are plenty of other foreclosure-related problems out there that could use some attention too.