Loan modification entitlement will be rescinded as prices near the peak
Last year I pointed out that loan modifications are not an entitlement, banks don’t want to make them one. That’s not how borrowers see it. One of the moral hazard consequences of the housing bubble is a belief among borrowers that if they get in trouble, they will be given an opportunity to reduce their mortgage payments and stay in their homes because that’s what happened over the last six years. However, the only reason borrowers were given special dispensation is because the banks were desperate and had no other viable alternatives. From Must-sell shadow inventory has morphed into can’t-sell cloud inventory:
The necessity of loan modifications
Ostensibly, loanowners and lenders agreed to the price of money (interest rate and payment) when the promissory note was signed. Unfortunately, during the housing bubble, the terms of these notes were onerous, and many borrowers faced excessive monthly housing costs while simultaneously facing declining house prices and the elimination of their equity. This prompted many borrowers to strategically default, and lenders are very worried that more would follow. Banks are still exposed to $1 trillion in unsecured mortgage debt. The threat of strategic default and the reality of a trillion dollars in unsecured debt forced the banks to renegotiate the terms of the original promissory note, and loan modifications became a feature on the real estate landscape.
Lenders don’t want to make loan modifications. If the borrowers had equity, they would simply foreclose on them and get their money back. Since so many are so far underwater, the banks can’t foreclose on them and get all of their money back, so it’s in their best interest to cut deals, amend loan terms, kick the can, and pray these borrowers will make payments until prices come back. At that point, things change back in favor of the banks, and their motivation to be accommodating and make loan modifications will vanish. Many people have come to view loan modifications as a new housing entitlement. It won’t be. The moment borrowers are no longer underwater, the entitlement will be rescinded by the banks. Remember, they would rather foreclose and get their money back so they can loan it to someone who will make payments based on the original contract terms.
The loan modification entitlement will not reappear unless house prices crash again and millions of borrowers find themselves deeply underwater with a huge incentive to strategically default. If those conditions don’t reappear, the willingness of banks to modify loans won’t reappear either. If banks find it in their best interest to foreclose and get their money back to loan to someone else, that’s what they will do. Unless there are millions of borrowers in the same circumstances, banks won’t feel political pressure to keep “struggling borrowers in their homes.”
Loan Modifications are the new incarnation of serial refinancing
When people bought homes during the housing bubble, they often used toxic financing terms like teaser rates, negative amortization, and other parlor tricks to get themselves into a home they couldn’t afford. Their plan was generally to refinance into a new loan in a few years when their payments skyrocketed. Ostensibly, there were going to get stable financing in the future, but realistically most would have opted for another toxic loan to keep their costs down while they made huge profits on appreciation. The process was known as serial refinancing, and many people fell for it. The false assumption they all shared was that another toxic loan would always be available. The credit crunch rudely exposed the folly of that belief.
Right now, many people who’ve obtained loan modifications believe that when the terms of their modification change back in favor of the banks (most changes to terms are temporary) that they will be offered another loan modification on favorable terms. If they are still deeply underwater, they might be offered another because the bank will want to continue kicking the can, but if they aren’t underwater, the serial refinancing of loan modifications will abruptly end.
A profile in can kicking
Loan modifications are a method to delay foreclosure on the millions of underwater borrowers. The problem is not small. Mortgage delinquencies at major banks still more than 12 times normal. To foreclose on them now would expose the banks to a $1 trillion in losses on their unsecured mortgage debt. Obviously, they don’t want to do that.
Loan modifications don’t work. About 40% redefault each year adding to the backlog of delinquent loans. For example, according to the article below, 80,000 loan modifications were granted in January, by the end of the year, 36,000 or more of them will redefault, and many have defaulted several times. Does that sound particularly successful to you?
The primary way loan modifications get resolved permanently is through short sale or foreclosure. There were more short sales and foreclosures in January than loan modifications. Between the new loan modifications, short sales, and foreclosures, the delinquency rate should be dropping. It isn’t. Contrary to media spin, mortgage delinquencies are trending higher.
So why are delinquencies still rising when so many loan modifications, short sales and foreclosures have occurred? Because plenty of new mortgages default each month. Redefaults are a big contributor, but residual mortgage distress from the millions of overextended borrowers is prompting many new defaults as well.
HOPE NOW has released its January 2013 loan modification data. An estimated 78,397 homeowners received permanent, affordable loan modifications from mortgage servicers during the month. This includes modifications completed under both proprietary programs and the government’s Home Affordable Modification Program (HAMP). The January total of 78,397 loan modifications brings the total number of permanent loan modifications since 2007 to 6.15 million.
According to HOPE NOW, since 2007:
►5,002,409 homeowners have received proprietary loan modifications.
►1,151,340 homeowners have received HAMP modifications (Note: HAMP reporting began in 2009).
In the internet world, when examining performance metrics, one of the problems people have is looking at what are called vanity metrics. A vanity metric is a measure that consistently rises but reveals little about the success or struggles of the company. One of the most common vanity metrics is cumulative number of visitors. It reveals nothing, but it makes people feel good to see a chart of steadily rising numbers.
The fact that HOPE NOW reports the total number of loan modifications granted since 2007 shows it’s political purpose. In fact, since many people are on their second or third loan modification, the numbers get inflated further with people who are obviously failing.
If HOPE NOW wanted to report on true success stories, I would like to see the total number of loan modifications where the borrower has remained current since inception. The number would be much smaller. Also, I would like to see the total number of loan modifications that were terminated in an equity sale. That’s the definition of success that a loanowner would use. I imagine that number is near zero.
HOPE NOW is aptly named. It provides nothing by hope in the now. Unfortunately, it’s largely a false hope.
For the month of January:
►63,539 homeowners received proprietary loan modifications.
►14,858 homeowners received HAMP modifications.
Loan modifications completed via proprietary programs once again showed characteristics of sustainability and affordability for homeowners.
For the month of January:
►Proprietary loan modifications that included fixed interest rates of five years or more accounted for 88 percent (55,698) of the total.
Note that after five years, the interest rates will go back up. This is the same teaser rate financing that was recently banned by the qualified mortgage rules. Think about that, the terms of loan modifications do not conform to the new standards established for qualified mortgages. Not even close.
►Proprietary loan modifications with reduced principal and interest monthly payments accounted for 85 percent (54,113) of the total.
►Proprietary loan modifications with reduced principal and interest payments of more than 10% accounted for 76 percent (48,595) of the total.
You can see from the chart above that most loan modifications are being done by commercial banks rather than HAMP eligible loans owned by the GSEs. Why is that? Because due to their sky-high delinquency rates, the banks are the most motivated to kick the can.
Short sales for January were 29,244, for a total of approximately 1,182,283 since December 2009. The combination of loan modifications and short sales has brought the total number of permanent, non-foreclosure solutions to approximately 7.33 million.
In the month of January 2013, there were 60,412 foreclosure sales completed, compared to 78,734 completed in January 2012. Also in the month of January, there were 140,482 foreclosure starts reported, compared to 200,447 reported in 2012.
Delinquencies of 60 days or more were at 2.53 million, compared to 2.77 million in January of 2012—a decline of almost nine percent. Delinquency data is extrapolated from data received by the Mortgage Bankers Association for the fourth quarter of 2012.
So in January there were 78,451 loan modifications and 89,656 short sales and foreclosures. There were fewer loanowners “saved” than “terminated.” Do you think loanowners call that a success? I rather doubt it.