John Lounsbury

Lenders, Loan Modifications and Coming 'Cram-Downs'

The reason mortgage modifications have had such a high failure rate (50-60% foreclosures 3-6 months after modification) is that many of these modifications were ill-conceived. If a modification reduces mortgage payment burden from 55% of income to 50% of income, it is doomed to failure in most cases. Unless housing costs are reduced to 38% of income or less (the standard accepted for calculating mortgage limits until the recent insanity), only the monastic will avoid default.

Many desperate, over-extended mortgagees will grasp at any straw in an attempt to avoid foreclosure. They do not have the basic financial skills to assess prudent action or they would not have mortgaged over their head to begin with. More than a few $75,000 income mortgagees will jump at a modification that brings their monthly mortgage payment, initially $3500, down to $3100. Many will not stop to determine whether their budget will balance.

Why do the lenders make ineffective modifications? I'll give a list (probably far from complete):
1. They will gain some decrease in foreclosures, although based on what has happened so far, it will probably be below 40% of the modifies.
2. They expect that the number of payments will be increased before foreclosure, giving them a marginally improved return.
3. They expect the average time to foreclosure will increase and lessen the holding time of those foreclosed properties (until housing sales volumes start improving).
4. Improve the lender's public image: We're good guys, we try to help.

Mortgage modification is a solution for only some mortgagees. It will have a reasonable success rate only when the resulting housing costs are reduced to a manageable percentage of income (38% max guideline) and the current market value of the home is not substantially below the new mortgage principle.

By the way, the 38% includes not only mortgage payments, but also property taxes and insurance.