Credit Agency: Some Mortgage Modification Strategies Better than Others

Fallout from the collapse of the U.S. housing market is ongoing, and consumers are only now beginning to learn the effectiveness of various mortgage modification strategies that they used after the collapse.

Nearly half of the homeowners who negotiated changes to their mortgages found themselves 60 or more days behind on their new home loans, according to TransUnion, one of three large credit-reporting agencies.

The Best Type of Mortgage Modification

TransUnion evaluated more than five million mortgages and 500,000 loan modifications and discovered the recidivism rate of just over 40 percent one year after the modification. That number rose to 60 percent after 18 months.

The numbers indicate that long-range toll exacted on homeowners may be even greater than first believed.

A study by the Amherst Securities Group, a broker in mortgage-backed securities, suggests that the types of mortgage modifications favored by lenders since 2009 performed badly, or provided only temporary relief, because they were tilted toward interest rate reduction and forbearance (which only delays mortgage payments) and away from principal reduction.

Only 12 percent of borrowers who received principal reductions re-defaulted in 2011, according to the Amherst study. That compared with 23 percent of borrowers whose modifications offered reduced interest rates only and 30 percent who received forbearance.

Since 2006, 5.5 million Americans have had their mortgages modified. Another 4.8 million are teetering on the edge of default.

Banks seem to have gotten the message that modifications with principal forgiveness are the most effective arrangements for keeping people in their homes and retaining them as paying clients. Principal reductions accounted for 40 percent of their modifications so far in 2012, up from 25 percent in 2011 and 11 percent in 2010.

According to the U.S. Treasury Department, the typical amount of debt forgiveness in a principal-reduction modification is approximately $60,000.

Other Factors

Adding to the mortgage modification picture is a federal government requirement that large banks spend at least $13 billion for reducing principal on loans for underwater borrowers who are either delinquent or at imminent risk of default.

Five big banks — Wells Fargo, JPMorgan Chase, Citigroup, Bank of America and Ally Financial – were saddled with that obligation, according to the settlement terms reached between the big five and the federal government and forty-nine states.

In addition, more than half of the outstanding U.S. mortgages are backed by either Fannie Mae or Freddie Mac, two former government-sponsored enterprises that are now wards of the Federal Housing Finance Agency (FHFA).

FHFA has prohibited Fannie and Freddie from including any principal forgiveness on the loans they hold, only permitting modifications under the auspices of the Home Affordable Modification Program (HAMP), with its preference for interest rate reduction and forbearance.

Fannie and Freddie released a report recently that touted their success in helping to keep 1.9 million borrowers in their homes by providing nearly 2.3 million foreclosure prevention actions from the beginning of their take-over by the federal government in September 2008 to March 2012.

But over the reluctance of the FHFA, bi-partisan legislation was introduced to mandate the inclusion of principal reduction programs for Fannie Mae and Freddie Mac borrowers.