Many homeowners who have been given a break on their troubled mortgages quickly end up in trouble again, a growing problem that is bedeviling efforts to stem rising foreclosure rates.
A recent study by the Office of the Comptroller of the Currency found that more than 50 percent of troubled homeowners had missed at least one payment six months after a lender modified their loan, and lenders and other researchers report similar default rates on modified mortgages.
The high default rate on reworked mortgages is complicating efforts to address a housing crisis that is already among the worst on record. It has sent government and industry officials scrambling to find new fixes as President Obama's administration pledges to spend $50 billion to $100 billion to help homeowners. A 50 percent recidivism rate "is an indicator that there are problems," said John C. Dugan, comptroller of the currency, whose office regulates some mortgage lenders. "Not just that the number is high, but that it keeps getting worse each month."
Many in Congress are questioning the effectiveness of loan-modification programs launched by the banking industry last year. "It's been going on for a year and half. The industry said, 'Don't worry; we have it under control.' It is painfully clear that sustainable voluntary modifications just aren't happening," said Rep. Brad Miller (D-N.C.). Miller is pushing legislation -- opposed by the financial services industry -- to allow bankruptcy judges to modify mortgages on primary residences.
"It's troubling to see a large number aren't staying current, but we don't know why," said Faith Schwartz, executive director of Hope Now, an alliance of lenders. "It can be because they lost their job. It's something new that has happened."
Most modifications aim to prevent foreclosure, and they succeed at that in the short term. The question is whether they work in the long term, or even for more than a few months. A review of reports indicates that the success of a modification can hinge on the type of changes the lender makes. According to a recent Credit Suisse report on subprime loans, those that were modified by lowering the interest rate or the principal balance owed were the least likely to become delinquent again. Modifications in which lenders simply gave homeowners time to catch up but raised monthly payments to cover missed amounts and late fees, or lowered interest rates for a time but then restored the rates to their previous level, were the least successful.
Jeanine Wilson continues to struggle despite modifications to the mortgage on her Upper Marlboro home. Her first modification, in May, increased her payments by $200 a month after her lender attached late fees and the missed payments. The second modification came after she was laid off as a social worker for the District government. Her interest rate was reduced, but though she was holding two new jobs, she still continued to miss payments, she said.
"They just kept saying they were in the business of making money, not in the business of helping you save your home -- either you pay it or you don't pay it," Wilson said.
In a recent study, Alan M. White, an assistant law professor at Valparaiso University, found that even with housing prices dropping rapidly, lenders have been reluctant to lower the borrower's principal. Instead, the average modification adds $10,000 to the principal owed by the homeowner, he found.
That has contributed to a higher re-default rate, White said. "Negative equity is the biggest predictor of re-default," he said. "If you have equity, you can always sell your house and you get some money and get a fresh start. . . . They are less motivated to struggle to make payments if they are underwater on their house."
In other cases, problems have occurred because the mortgage modifications were done without sufficient information, experts said. Charles W. Scharf, J.P. Morgan Chase's chief executive for retail financial services, said that when his bank bought Washington Mutual and Bear Stearns last year, it knew there were hundreds of thousands of troubled mortgages between them. But it was a surprise that many borrowers were not required to prove their income before receiving a modification. The result is that homeowners got modified loans they could not afford.
"A lot of the modifications that have been done were not exactly the most intelligently done," Scharf said. J.P. Morgan began applying its income-verification requirement to the loans acquired in October and expects performance to improve significantly, he said.
Some are concerned that a focus on re-default rates could discourage loan modifications. "That data just makes me wonder what kind of modifications those national banks and thrifts are doing. Were they sustainable?" said Mark Pearce, North Carolina's deputy commissioner of banks and a member the State Foreclosure Prevention Working Group. "We're a little afraid that this statistic may lead people to the conclusion that modifications aren't working, when some are being done the right way and are working."
Some lenders have launched more aggressive programs. Bank of America's program aims to lower payments to 34 percent of gross income. "The majority of customers who re-default have experienced an additional financial hardship due to the continued deterioration of the economy since the initial loan workout was completed," said Jumana Bauwens, a spokeswoman for Bank of America.
But lenders and government officials caution that there are dangers in modifying mortgages too dramatically. "There are very difficult issues of consumer behavior at work. If you make something too generous, you don't want to give incentives to people who have been paying their mortgage on time to default on their own mortgages in order to get a deal like the guy next door to them," said Dugan, who said his office is trying to develop a plan that strikes the right balance.
The government has four major initiatives to help homeowners who face mortgage trouble, and it is bracing for significant re-default problems with some of them.
Last week, the Federal Reserve announced a modification program for loans it controls through its takeovers of Bear Stearns and AIG. It plans greater emphasis on reducing the amount of principal owed.
In the government's largest foreclosure program, known as Hope for Homeowners, about 40 percent of homeowners are expected to fall behind on payments again, according to Office of Management and Budget estimates. The Federal Deposit Insurance Corp. has developed a loan-modification plan for customers of the failed bank IndyMac that it has touted as a potential industry model, but that program is also preparing for a 40 percent re-default rate.
Another government program to help homeowners, known as FHASecure, expects about a quarter of homeowners to become delinquent -- more than double the delinquency rate for traditional Federal Housing Administration loans. Unlike the other two programs, these loans were available to people who were not yet in default.
As the economy continues to slow, layoffs mount and housing prices drop more, making it even harder for homeowners to sell their homes to pay off their loans, the default rate is expected to rise. "As the economy worsens, we're going to see defaults and re-defaults go up," said FDIC Chairman Sheila C. Bair. "That's just going to happen. People need to understand that."
But Bair said the fact that some loans go bad again doesn't necessarily mean loan-modification efforts are the wrong approach. The average modification saves the lender $50,000 over the cost of a foreclosure, she said.
"We could go to a re-default [rate] higher than 40 percent and still be making money off of these loan modifications just because the savings from the successful ones is so much greater than the ones that re-default," Bair said.