Why Loan Mods Fail

Floyd Norris asks an interesting question: Why do so few mortgage mods turn permanent?

He sifts through many of the close-but-no-cigar-answers: There were many bad loans made in the first place; modifying loans to unqualified borrowers isn’t doing much good. Many other small factors are preventing mods from being successful.

Some of the modification techniques are simply laughable: Mods still use declared income, i.e., no income verification of borrowers – hey, lenders, how did that work out the first time you employed that technique? Not too good, right?

Here is the quandary as described by Norris:

“The banks, and the government, are soon going to have to decide what to do about borrowers who are making the modified payments but have not provided the documents after repeated efforts to obtain them. Should the banks just take the money and let the preliminary modification turn permanent? Or should they foreclose?

Those decisions will affect just how fair the program is seen to be. If the banks allow those who do not submit documents to get by without doing so, it will appear unfair to those who told the truth about their income, and paid more than they might otherwise have been required to pay. If they do not, the wave of foreclosures could devastate more neighborhoods.”

Yes, all that maybe true. Unfortunately, it does not get to the central factor of foreclosures and therefore loan mods: You can convert a variable APR to a fixed loan, extend a 30 year to a 40 year. You can even defer some small portion of principal — interest-free – for 40 years or until the house is sold.

And mods continue to fail the majority of the time.

The bottom line is simply this: Buyers paid too much for their homes; Banks lent out too much money relative to value.

And so because of these 2 simple factors, the entire real estate sector is repricing towards a healthy intrinsic value, relative to competitive factors: Income, Renting, and GDP.

Until that process is completed – and all evidence suggests that it is not – then these mods that do not significantly adjust amounts owed are destined to fail.

Why Many Home Loan Modifications Fail
NYT, December 4, 2009

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