Why Mortgage Mods Aren't Working

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When the Obama administration announced its Making Home Affordable program early last year, it looked like a win-win strategy for helping troubled homeowners and their lenders.

Homeowners would save money from payment reductions. Lenders would settle for less than they were due but would come out better than if they had to sell foreclosed properties in a depressed market.

So, why is the program failing? Even the Obama administration admits its loan modification program has fallen far short of its original goal, helping only about 300,000 of the 1.7 million homeowners believed eligible. Applications have dropped.

It seems likely that if the lenders felt this was a good deal for them they’d find ways to encourage more applications. The paperwork logjam would be cleared and applicants’ phone calls would be quickly returned.

Some lenders may be in denial, wrestling with contract obligations to mortgage-securities investors, or reluctant to acknowledge the size of their mortgage losses to themselves or their shareholders. There may be a tendency to stall in hopes conditions will turn around. After all, the economy is now creating jobs, making it easier for more homeowners to continue making their payments.

Many lenders and borrowers are also in a game of chicken. In any given case, the lender can’t know for sure that a borrower who falls behind will really walk away in the end. If a borrower does resume payments, the lender is better off for having kept the original loan terms instead of cutting the homeowner a break.

Lenders are supposed to be good at assessing these things, but the mortgage mess proves they can make mistakes. On the other hand, they may have it right. Why go to a lot of trouble and expense to negotiate a better deal with a homeowner who’s going to default anyway?

Many qualifying homeowners may be unaware of the program. Some may simply be procrastinating, hoping their problems will go away or that the lender will forget about them. Some may fear drawing attention to misstatements they made in their original mortgage applications, such as exaggerating income.

And others may be assessing the situation quite rationally. Most mortgage-modification applicants who have received help got reductions in interest rates designed to cut monthly payments. But that doesn’t help with the other widespread problem: owing more than the home is worth.

An estimated 15 million homeowners are underwater, with 9 million owing at least 25% more than their home’s current value. Even if the monthly payment is affordable, many of these homeowners may choose not to spend tens of thousands of dollars to pay for equity that has disappeared. For them, paying the mortgage has all the appeal of paying a gambling debt.

The program allows lenders to reduce a borrower’s principal but this happens rarely, as it can produce a bigger loss for the lender than an interest rate cut.

So it doesn’t look like the Obama program is going to make much of a dent in the housing problem. If millions of homeowners walk away from their properties or are forced into foreclosure, home prices will continue to languish.

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