Over Half Of All Loan Modifications Fail Within One Year

This article originally appeared on the Irvine Housing Blog.

Loan modifications fail at a very high rate, not because borrowers are unemployed, but because borrowers were Ponzi borrowing, and now they are being cut off from credit necessary to continue making their payments.

I wanna go back
I wanna go back
Uh cause I remember way back when
Got kicked out the crib and had a place to stay

Sometimes I cant help but think, I Wanna Go Back
I Wanna Go Back…back in the time
I Wanna Go Back
I Wanna Go Back…go way back way back y’all
I Wanna Go Back…back in the time

Kid Rock — I wanna Go Back

Everyone who participated in the Great Housing Bubble wants to go back to the way things were before. That is the problem with Ponzi schemes; once they collapse, you can’t rebuild them. Borrowers were only making their debt-service payments by borrowing more money. When faced with the prospect of paying their debts without continued borrowing, Ponzis can’t do it.

Loan modifications seem like a great idea: borrowers resume making payments and get to keep their houses, and lenders don’t have to foreclose and recognize any losses. In other circumstances, this solution may have worked, but with recidivism rates exceeding 50%, these programs are largely a failure.

Imagine a residential real estate market where all the owners borrowed using fixed-rate financing with at least 20% down and reasonable debt-to-income ratios and there was limited mortgage equity withdrawal (think Texas). A market like that would have significant equity and owners capable to withstanding some financial distress. An economic downturn would cause problems, but in a market like that, loan modification programs offering temporary payment relief would probably keep a majority of homeowners in their properties.

Unfortunately, that is not our housing market.

Borrowers in our market used 100% financing with debt-to-income ratios exceeding 50% and borrowed any equity as it appeared. In a market that has gone Ponzi, people can’t afford their debt-service payments without additional debt. That is the essence of a Ponzi scheme. Loan modifications will not be successful in a Ponzi market because borrowers could not afford the debt prior to the financial distress. Therefore, loan modifications in our current market environment are doomed, and the statistics prove it.

Mortgage Mods: Most Borrowers Are Likely to Redefault Within a Year

By Lita Epstein

Mortgage modifications may not be the solution to the nation’s housing problems, after all. Fitch Ratings predicts that 65 percent to 75 percent of modifications on subprime mortgages will redefault in 12 months. The redefault level predicted for prime loans that have been modified is slightly lower — 55 percent to 65 percent within 12 months of modification.

Along with foreclosures, the use of short sales and short payoffs increased in 2009, according the the recent report from Fitch. “Currently 50 percent of prime and 35 percent of subprime and Alt A distressed liquidation sales are not by REO [lender-owned] sale,” according to Fitch. The percentage of loans that ended up in foreclosure was 25.7 percent by the end of 2009, up from 11.7 percent in the first half of that year.

All those statistics show how little can be done to help people as long as the job market continues to be weak.

Even when the job market picks up, these statistics will not improve. These borrowers went Ponzi. The only thing the recession did was accelerate their financial demise.

Yet Fitch said that “potential new moratoriums and mandated mediations are becoming more widely required,” which Fitch thinks will delay final resolution on many of these properties until sometime in 2012. So we’re still looking at distressed sales impacting the housing market for at least another two years. Maybe these delays will be long enough to help some people find a job and keep their homes.

Hope is not a plan, but that is all lenders have. Everyone seems to think they are benefiting from the amend-pretend-extend policies of lenders. Expect that behavior to continue until the cartel falls apart.

The good news for borrowers looking to get out of property underwater is that short sales appear to be increasing in popularity. While lenders have discouraged short sales until recently, the use of short sales has increased since mid-2009.

California leads the way in the use of short sales. Fitch found that 50 percent of all short sales or short payoffs were located in California. About 8 percent were in Florida and 7 percent in Arizona. With new guidelines from the Obama administration changing the rules for short sales, Fitch expects the percentage of loans “liquidated outside of REO sale will continue to increase.”

Short sales are the solution du jour. Once lenders realize that will not solve the problem, look for foreclosure rates to go back up… unless lenders are going to enable permanent squatting through gifts of homes.

Even when a home defaults, it does not necessarily result in foreclosure. Fitch found that about 15 percent of all modified non-agency residential mortgage back securities (RMBS) get additional modifications. Of the modifications that were completed in the first quarter of 2009, 18 percent have been remodified to date.

Second, third, forth modifications. The amend-pretend-extend dance is getting ridiculous.

The data for the U.S. Treasury’s Home Affordable Modification Program (HAMP) still are not available, since the first completed modifications under HAMP were seen in July 2009. Of the 1.7 million loans identified as HAMP eligible, 1.4 million were offered a trial plan by their servicer, but only 299,000 had actually converted to a permanent modification plan. Fitch expects that these modifications will default at about the same rate as the RMBS modifications.

Those modifications could show up later in the process, since the reduced payments are allowed over a five-year period. Then the payments increase to established caps.

When those payments start increasing another wave a defaults could be been.

No, when those payments start increasing there will be another wave of defaults. The policies being implemented by lenders will ensure we have supplies of distressed properties for many years to come.