The lynchpin of President Barack Obama's plan to rescue troubled home owners--and the housing market as a whole--is a sweeping effort to restructure distressed home loans through a process known as "mortgage modifications." The plan offers cash incentives to mortgage servicers who agree to bring a borrower's monthly loan payments down to 31 percent of their gross monthly income. The administration believes that making monthly mortgage bills more manageable will limit the home foreclosures that are putting such downward pressure on real estate prices.
But mortgage modifications have a checkered history of success. The Office of the Comptroller of the Currency, for example, says that almost 53 percent of loans modified in the first quarter of 2008 went bad again within six months. Proponents of loan modifications, meanwhile, argue that the approach can work--as long as mortgages are restructured the right way. The first-quarter mortgage metrics report released Wednesday by the OCC and the Office of Thrift Supervision included detailed findings on the mortgage industry's efforts to modify home loans so far. Here are five things you should know:
(It's important to note, however, that the Obama administrations loan modification plan was implemented after the conclusion of the first quarter, so it's impact is not reflected in this report.)
1. More Modifications: The regulators reported a sharp increase in the number of loan modifications that were initiated during the period. "Newly initiated loan modifications reached 185,156 during the quarter—rising by 55.3 percent from the previous quarter and 172.3 percent from the first quarter of 2008," the regulators said in the report. "The impact of this increase in modifications on reducing foreclosures and enabling borrowers to remain current on their loans will only be seen in future data."
2. Rate reductions most popular: The Obama administration's plan gives servicers a slew of options for bringing a borrower's debt-to-income ratio down to that 31-percent threshold. But the report finds that reducing the interest rate and extending the terms of the loan were the most popular approaches for reducing payments in the first quarter. "Of the modifications made in the first quarter of 2009, 70.2 percent included a capitalization of missed payments and fees, 63.2 percent included a reduction in interest rate, and 25.1 included an extended term," the regulators said in the report. "By comparison, 12.6 percent of the mortgages received modifications that froze the interest rate, 1.8 percent included a reduction of principal, and 1.1 percent included a deferral of principal."
3. More monthly payments reduced: Supporters of loan modifications argue that the approach has not been effective in the past on account of poor execution. Specifically, they note that often times a modified mortgage actually results in a higher monthly mortgage payment for the borrower. Lowering monthly payments is a key component of the Obama plan. But even before it was implemented, servicers were already taking steps to bring down monthly payments, the regulators found:
Modifications during the first quarter of 2009 resulted in lower monthly principal and interest payments on 54.1 percent of all modified loans, as servicers focused on achieving more sustainable mortgage payments. The number of modifications that reduced payments by 20 percent or more nearly doubled in the first quarter compared with the previous quarter, increasing to 29.3 of all first quarter modifications and exceeding all other categories. Modifications that increased monthly payments declined to 18.5 percent of all modifications during the quarter, down from 25 percent in the fourth quarter and 33.5 percent in the third quarter. Actions that left payments unchanged increased to 27.3 percent.
4. Bigger reductions, better performance: This isn't terribly surprising, but it's worth pointing out that loan modifications that reduce monthly payments significantly have lower redefault rates.
5. Performance: It is still too soon to tell if the reduced-monthly-payment approach will drive down redefault rates significantly. Nevertheless, here is a breakdown of how mortgages that were modified last year have performed so far: