Foreclosures not being Contained by Loan Modifications

The Obama administration had launched a loan modification and refinancing scheme with much fanfare but unfortunately numerous instances of loan re-defaults are being reported. After modification the monthly amount has increased rather than decreased.

Servicers have complained that they only service the loans and do not have the authority to negotiate. But some kinds of loan can be modified without the approval stamp of the investor. Lenders and the investors are shying away from reducing the principal because it involves writing down the value of the loan. On the other hand if for the time being the interest is reduced but additions are made to the principal, then loss is avoided.

Some have calculated that the lenders stand to gain if they do not modify the mortgage. According to the findings of a paper of Federal Reserve Bank of Boston, over 30% of the defaulting borrowers fix up the problem by themselves and manage to become current even without outside help. As such why should the lender let go of such opportunities and go out of their way to modify mortgages?

The falling market value has made the lenders reluctant to modify loans. The calculation by the lender is that greater losses will be incurred if the house in any case goes into foreclosure even after modifying the loan.

Some lenders contend that some borrowers are purposefully defaulting. These borrowers are those who have gone underwater – their loan amount being more than the falling value of the house. After having made the lender take the trouble and spend the time in modifying the loan these borrowers walk away leaving the lender facing greater losses.

Jack Shackett of Bank of America said, “We have customers who can afford the payments but are underwater. They default not because they have to, but because it’s better for them. They can act like they want the modification and then they still default, so they’ve stayed for three to four months in the house for free.”

The government is aware of these hurdles and doing its level best to overcome them. For this very purpose the three month trial period has been introduced. The emphasis of the government is on seeing that the monthly payments are lowered after modification. Michael Barr, assistant secretary for financial institutions at the Treasury said, “In the past, modification increased the burdens on borrowers. Under the president’s plan, it reduces payments to a meaningful level. Investors and servicers get incentives and are paid only if loans succeed.”

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