Why Many Home Loan Modifications Fail

Why are so few temporary mortgage modifications turning permanent?

One reason may be the same one that a lot of bad loans were made in the first place. Borrowers can declare their income, and the banks are willing to grant temporary modifications based on those figures, without any evidence to confirm them.

But to make a modification permanent, the banks have to see proof of income, and the borrower has to make three monthly payments of the new lower amount. In most cases, those requirements are not being met.

Thousands attend a mobile foreclosure prevention clinic in Daly City, California.
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Thousands attend a mobile foreclosure prevention clinic in Daly City, California.

The banks, and the government, are soon going to have to decide what to do about borrowers who are making the modified payments but have not provided the documents after repeated efforts to obtain them. Should the banks just take the money and let the preliminary modification turn permanent? Or should they foreclose?

Those decisions will affect just how fair the program is seen to be. If the banks allow those who do not submit documents to get by without doing so, it will appear unfair to those who told the truth about their income, and paid more than they might otherwise have been required to pay. If they do not, the wave of foreclosures could devastate more neighborhoods.

The rules now being applied, in some cases clumsily, had a Goldilocks quality; to get a modification a borrower had to need it a lot, but not too much. If the home was “underwater” — worth less than the balance of the loan securing it — but the borrower could still afford the payments, there was to be no modification. If the borrower was in such bad straits that default was likely even with a modification, again that borrower was supposed to be turned down.

And banks were supposed to refuse modifications if they could do better by foreclosing, whatever the effect on the borrower.

Nearly two months ago, I spent a day at a JPMorgan Chase call center in Jacksonville, Fla., where employees had once worked the phones trying to persuade people to take out mortgages. Now the hundreds of desks were filled by people trying to arrange modifications of loans made by Chase or Washington Mutual, whose assets JPMorgan Chase acquired after that bank was closed by the government.

One of the most frustrated Chase employees I met was Domonique Perez, whose job was to round up the documents from borrowers who had been granted temporary modifications.

It was, she said, not going well.

She told of one man who had filed almost all the necessary documents — the permission slip for Chase to look at old tax returns, the pay stubs for current income — but not the affidavit of financial hardship. She had called and called, she said, and sent letters by regular mail and by FedEx, but the man was not getting back to her.

When I called Ms. Perez again this week, she did not recall what had happened in that case. But over all, she said, “it’s getting a little better. I’m getting a lot more files that do have all the documents.”

It will need to get a lot better. Chase disclosed in November that nearly a quarter of trial modifications had failed because the borrower did not make even a single payment, and that nearly half had failed to make all three payments required before the modification could become permanent.

Of those who had made all three payments, only about a quarter had submitted all the required documents.

Updated numbers will be released next week. “It is getting better,” David Lowman, the chief executive of Chase’s mortgage business, told me this week. But the gains are in contrast to a very low level of compliance.

In Washington, there are suspicions that banks simply are not trying, that they do not really want to make modifications. There is talk of shaming them into action. Tempers may run hot when bankers meet with Treasury officials on Monday and then testify before a Congressional committee on Tuesday.

Listening in on calls to the Jacksonville center gave me a perspective on what was going on.

The Chase representatives appeared eager to approve modifications, and were prepared to believe anything people said about their income. Modifications went to those who came up with the right income number, neither too high to qualify nor too low to be likely to meet the modified payments.

I listened to one call from a woman who sounded as if her world were collapsing. She and her husband operated a business, which seemed to be teetering near collapse, and its finances were intertwined with theirs. They were behind in payments on their mortgage.

Under the administration’s mortgage modification program, the new payment, including escrow payments for taxes and insurance, is to be 31 percent of the borrower’s gross monthly income. The woman first said their income was $6,000 a month, the amount they had taken out of the business when times were good.

The process of cleaning up

That number, it turned out, was too high to qualify for a modification. When told that, the woman said she thought that for at least the next couple of months, they might be able to take only $2,000. That number was too low. She got no modification that day. Had she come up with a number somewhere in between, she might have qualified.

The arithmetic of “Obama mods,” as some call them, is laid out by the government. The 31 percent number is fixed in stone, which provides some simplicity but also can be arbitrary. A family with a lot of other obligations might not be able to afford 31 percent, while one with few other debts could afford much more.

To get the payment down to the 31 percent figure, the bank first cuts the interest rate, to as low as 2 percent, while leaving the other terms of the mortgage unchanged. For the vast majority of mortgages being modified, that is enough. If not, the term of the mortgage is stretched out to as long as 40 years.

Finally, if that is not enough, part of the principal can be deferred. That deferred amount is still owed, but no interest accrues and the lump sum is due at the end of the 40 years, or when the house is sold.

Calculating those numbers is only the first step. After determining the present value of that projected series of payments, the bank then compares it with what it could get by foreclosing. If the bank would be better off by foreclosing, then there is no modification.

One thing working in borrowers’ favor is that foreclosure values are heavily discounted to take into account the delays involved in the process, the costs of maintaining a home until it can be sold and the possibility that property values will continue to fall.

In one case I saw, the house was estimated to be worth $227,100, far less than was owed. The present value of the payments to be made under the modified loan was $159,611. modification was nonetheless approved, and the monthly payment fell to $1,004 from $1,877.

What made the difference was the bank’s conclusion that it would get a present value of just $139,568 from a foreclosure, nearly 40 percent less than the estimated value: the low payments were worth more than the alternative.

All these numbers are based on a lot of assumptions — assumptions that few borrowers will be in a position to know, let alone challenge. And they have the perverse effect that modifications will be harder to get if property values improve, or even if they simply stabilize and seem likely to fall no further. That would make the foreclosure value appear higher to the banks.

It is far from clear that some modifications being granted are really in the borrowers’ interests. Some will be able to stay in homes when they could rent a comparable house for less, and will be so far underwater that they are unlikely to be able to sell the house for years without defaulting on the new terms. It is conceivable that this process is doing more to drag out the foreclosure crisis than to alleviate it.

But perhaps we should not be too critical of anybody involved in the modification effort, either the administration or those trying to arrange modifications. The mess was made years ago, when bad loans were made and the ready availability of credit was driving house values to unsustainable levels. Cleaning it up is not going to be a pleasant experience for anyone.