The Next Foreclosure Tsunami Could be 2014’s Modified Mortgages

by Carole Ellis

If your home loan was modified in 2014 or more recently, you are more likely than your counterparts to be looking at another delinquency. According to Fannie Mae loan data and Fitch Ratings analysts, loans modified since 2014 are redefaulting at much faster rates than those modified closer to the housing crash.  The reason is likely that loans modified in more recent years tended to be associated with lower FICO scores and prior mortgage modifications. Not surprisingly, borrowers who had to modify more than once tended to have a higher default risk.

To conduct the study, Fitch analyzed about 700,000 loans that were permanently modified between 2010 and 2015. Permanent loan modifications have made it through a trial period during which the borrower successfully met new payment requirements, and borrowers also have demonstrated to their lenders’ satisfaction that they have the means to continue making payments in the future. Trial modifications tend to last three months, but some lenders set longer trial periods if they believe that a borrower is at risk of defaulting on their existing mortgage or if the borrower has already attempted one or more loan modifications. The cumulative outstanding balance on the analyzed loans was $135 billion. Just over 350,000 of those loans had either redefaulted or been prepaid as of March 2016.

According to Fitch analysts, loans modified in 2009, average FICO scores on modified mortgages hovered around 655, and only about one in every 100 modified mortgages had a previous modification attempt. However, by 2015, average FICO score on a modification application was 592 and more than a third of the loans in question had been unsuccessfully modified at least once before. Samuel So, Fitch Ratings’ director, observed that more recent loans are more likely to default, with 2015 modifications being the most likely to default. Fitch also determined that borrowers are most likely to redefault within the first two years of modification.

Although FICO score and modification history were probably the most significant factors in whether or not a loan is going to redefault, loan modification programs are also good predictors of default risk. Fitch analysts found that standard modification programs have the highest cumulative redefault rates. The Home Affordable Mortgage Program (HAMP) had the best results, with HAMP loans being the least likely to redefault. The federal government’s “streamlined modification program” fell behind HAMP but performed better than the standard modification program. Since these programs all have different requirements and eligibility, it is not surprising that some would outperform others.

HAMP, the best performer, debuted in 2009 and was widely considered to be a mismanaged disaster, in large part because participation was voluntary, confusing, and not particularly rewarding for large lenders. Borrowers reported confusing application processes, unwarranted rejections even when they met all modification requirements, and extremely slow response times from lenders. Although the federal government had predicted that “as many as four million homeowners” would be able to modify their mortgages through the program, only a fraction of that number ever entered the program, much less successfully exited with a sustainable modification. HAMP expired at the end of 2016 with about 1.6 million homeowners having spent at least some time in a successful, “permanent” modification.

With HAMP out of the picture, most lenders say that they will continue to offer loan modification programs on a limited basis, and most major lenders offer foreclosure-prevention measures if homeowners know to ask. Fannie Mae and Freddie Mac, both still under federal conservatorship and two of the largest mortgage holders in the United States, recently adopted recommendations from the Mortgage Bankers Association (MBA) that they focus on payment reduction when modifying loans before anything else. The MBA said that after six years of research, the magic number is a 20-percent reduction of the homeowner’s monthly bill, even if it means that the life of the mortgage must be extended, principal forgiven, or interest rates reduced. “Payment reduction, more than anything else, matters the most in making a successful modification,” said Justin Wiseman, MBA director of loan administration policy. He added, “It sounds like the most obvious thing in the world, but it took us six years of data and research to get there.”

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