The Government’s Loan Modification Program Does Not Have To Fail

The government’s “Home Affordable Modification Program”  needed $75 billion of taxpayer money to alter home loans so that these loans could be more affordable for creditworthy homeowners who could not make their earlier mortgage payments. The program has been a failure for several reasons.
 The first is that lenders have only modified 760,000 loans. A mere 31,000 of these modified mortgages have passed through the approval process and were designated as permanently modified. Most of the people accepted into this mortgage modification program may never make it out of the trial stage. That means that the scope of the “Home Affordable Modification Program” will never come close to reaching its goals.
The true failure of this program is far worse than the limited scope of its help. A very large number of the mortgages which were modified are already in default. The executive summary of the Mortgage Metrics Report for Third Quarter 2009 issued by the Office of the Comptroller of the Currency and the Office of Thrift Supervision stated that 43% of modified loans made in the second quarter of this year were already 60 days past due. The report looks at the data in a number of ways which include how much the monthly mortgage payments dropped and how long the modifications had been in effect. Somewhere between a third and a half of people who have been given new, lower monthly payments cannot make those payments within a year when the entire program from its start last year is taken into account.
The reason that banks have not been enthusiastic about the government’s program is clear. There is a great deal of paper work and effort that goes into every modification. The lending institution then has to deal with a high number of new non-performing loans that were just recently modified.
The weaknesses of the plan could be solved in part by making changes in the program that should have been part of its original goals. Monthly payments in modified loans are obviously still set too high for many mortgage holders. The estimates of what people can pay must be flawed, if so many people default in such a short period. The modified payments need to be “tested” and changed, if necessary, as it become clear what people in the program can actually afford for monthly housing payments.
The other weakness of the program is that it changes monthly payments, but it does not alter the balance of the home loan. People faced with mortgages that are “underwater” because their mortgage balances are greater than the value of their homes are more likely to default on their loans than people who can make money when their houses are sold.
It is essential that the many accounting and regulatory issues involved with the alteration of the principle balances of mortgages be addressed quickly and systematically so that banks are not faced with huge write-offs if they reset the value of home loans.  Homeowners are unlikely to stay in houses for years with no prospect of a return on their investment.  There are a number of reasons that people will decide on home abandonment in favor of renting in these situation. This next step in the “Home Affordable Modification Program” work in progress must address these problems.

The government’s plan also does nothing to factor in the rise in unemployment. A person with a loan modified to more readily suit his income will default on his mortgage almost immediately if he loses his job. The government and the lending institution will have wasted large sums of capital and time. That process will repeat itself in increasing numbers if unemployment stays above 10% for most of next year. The home modification programs need a provision that will allow mortgage holders to have a standstill or moratorium on payments if they are out of work. Car companies do it with new auto owners. The government program needs to provide support for homeowners who desperately want to keep their homes.  People without jobs need to have a year while they search for new work before foreclosure occurs. The turnover of homes with people who have economic difficulties is otherwise far too great.

The default rate on modified mortgages may doom the most important programs of the “Home Affordable Modification Program”. But, it does not have to be that way.

Douglas A. McIntyre