HAMP Modifications Likely Unsustainable

by: Rolfe Winkler, CFA

Treasury’s March report for the its mortgage modification program shows another uptick in the number of so-called “permanent” modifications….

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It’s a positive trend, sure, but still not much to celebrate. The 231k borrowers that have received such mods represent only a fraction of total borrowers who are at-risk of default. Amherst Securities estimates that 7 million borrowers have already defaulted on their mortgage and another 5 million are at high risk of default.

But the bigger problem is that these “permanent” modifications are anything but permanent…

Screen shot 2010-04-15 at 12.53.22 AMAs you can see, relatively few borrowers are receiving principal forgiveness. Instead, most modifications rely on extend and pretend tactics like interest rate reductions and extended loan terms. Many loan modifications also simply add missed payments to the loan balance. Such tactics do nothing to solve the key problem of negative equity. Unless borrowers have skin in the game, they’ll have much less incentive to stay current.

The scarier stat is the so-called “back-end DTI” figure. At 61.3%, the average is up nearly 2% since last month.

This means that the average borrower receiving a “permanent” modification still faces total monthly debt payments — including home equity loans and all the other stuff mentioned in footnote 2 — amounting to 61.3% of monthly GROSS income. So even before taxes are taken out, nearly two-thirds of borrowers’ pay has to go to pay down debt, leaving little for other necessities.

The HAMP modification program only targets first mortgages for modification, and then only reduces payments on the first mortgage and other housing expenses to 31% of gross income. That’s high on its own, never mind all the other debt these borrowers are carrying. A program to modify second liens has launched, but won’t ramp up for a few months.

The bottom line is that HAMP mods are likely unsustainable. Expect many of these borrowers to re-default.