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Q Why is it so hard to make mortgage modifications work?

A With the collapse of the housing market, the number of borrowers experiencing some type of distress has reached historic proportions. One-fourth of homeowners owe more than their homes are worth, 17 percent are behind in their payments, and experts forecast as many as 13 million foreclosures over the next five years.

In response, the government has initiated various loan modification programs, beginning in 2008 and continuing with the Home Affordable Modification Program unveiled in early 2009.

Yet these efforts have been conspicuously ineffective, yielding only 170,000 permanent modifications. Given that a foreclosure costs the lender 30 percent to 60 percent of the loan value, why aren't more loans being renegotiated?

One obstacle is securitization. Mortgages originated by a bank are usually sold to an investment bank or a Government Sponsored Enterprise like Fannie Mae or Freddie Mac. These loans are bundled into types of bonds called mortgage-backed securities, or MBS, and sold in pieces to investors, so that one loan may literally have a thousand owners.

The originator often continues to service the mortgage (collecting and distributing payments), but may have limited or uncertain authority to cut a deal with a borrower absent the explicit consent of the bondholders. This is especially true with "private label" MBS that hold most of the sub-prime mortgages in greatest jeopardy.

Furthermore, these private-label MBS are typically subdivided into different risk pools or "tranches," whose investors disagree on the benefits of restructuring.

Another hurdle is the presence of a second lien. In most cases the servicer must obtain the approval of the second mortgage-holder to effect a significant modification of the first mortgage. Since the second lienholder is likely to be wiped out by any principal reduction agreement, such approval is rarely forthcoming.

Lenders and servicers also understand that restructured loans suffer high recidivism. Of the mortgages modified in the fourth quarter of 2008, 58 percent had redefaulted within one year.

Given this experience many lenders view modification as a costly distraction that may actually be delaying the necessary adjustment required to revivify the real estate market.

Recently announced revisions to HAMP address some of these obstacles. While the overall impact is still likely to be limited, the changes will prove beneficial for certain individual homeowners in distress. More information and an eligibility worksheet are available at makinghomeaffordable.gov.

Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Chris Hopkins is vice president, investments, at Barnett & Co. Inc. Submit questions to his attention by writing to Business Editor John Vass Jr., Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by e-mailing him at jvass@timesfreepress.com.

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