The Failure Of The Mortgage Modification System Threatens Housing

The theory was simple and elegant. By offering homeowners who could not afford their monthly mortgage costs lower monthly payments, people could be able to stay in their homes. That would lower the US default and foreclosure rate, in turn building a foundation under the housing market.

The programs are simple, but they appear to be a failure.

A report about to be issued by credit rating agency Fitch says that a large number of the people who get better terms for their monthly payments still walk away from their homes. According to The Wall Street Journal, “Fitch said a conservative projection was that between 65% and 75% of modified subprime loans will fall 60-days or more delinquent within 12 months of the loan change.” That makes the problem so severe that any effort to turn home prices back in the right direction is likely to fail.

Fitch believes that a major reason people still default on their home loans is that their mortgages are “underwater”. A homeowner whose home loan is worth 150% of the value of his house may believe that he has no chance to ever recoup the equity he has invested. He may be able to stay in his residence but over time it becomes more evident that there is no financial advantage to that.

The other, and perhaps more probable cause of defaults  among people who have secured better payment terms, is unemployment and under-employment. As the non-farm unemployment goes up by more than 500,000 people a month and businesses cut more people from full-time to part-time to save money, the ability of many homeowners to make mortgage payments disappears even if they desperately want to stay in their houses.

Banks do not want to cut the principal value of mortgages because it effects their balance sheets. That means that the issue of underwater mortgages may not be solved. And, the more serious issue, unemployment, shows no sign of moving in a direction that will help the housing market this year, in 2010, or even 2011.

Douglas A. McIntyre