Administration’s Anti-Foreclosure Plan has a Chance to Succeed

My colleagues at the Center for Community Capital at the University of North Carolina have just released a report showing that lower payments and principle write-downs can reduce mortgage foreclosures. This is noteworthy because the Administration’s plan to address the housing crisis relies on this common sense (but challenging to implement) approach. It’s a pretty good thing that the UNC folks have observed that it has the potential to work!

The latest market data reveal that almost 6 million mortgages are past due or in foreclosure—that’s 12 percent of the market. And 20 percent of all American homes are “underwater”—the lovely term meaning the amount owed to the bank as a mortgage exceeds the market value. Systematic loan restructuring is going to be the name of the game to avoid mass foreclosures and displacement.

Presently, some of the public money is being deployed to encourage servicers to reduce monthly payments to a percentage of household income. This can be done by lowering interest rates but the folks at UNC have found that writing down the principle due is also an essential tool to minimize longer-term default risk.

This is part of the Administration’s plan and this report should give support for those arguing to use this tool more often. The New York Times made just this point in a recent editorial. I am a fan of what the Administration and HUD Secretary Shaun Donovan are trying to achieve here, although it is worth noting that if people keep losing their jobs, it is going to make it even more difficult for this plan to succeed.

As with any good research, it is helpful to wade a bit into the details.

The results show that the type of modification matters. Six months after receiving a modification, homeowners who got a “traditional modification” — where past due amounts and fees are added to the loan and the payment rises — had a 60 percent higher rate of delinquency than those whose modification led to a reduced payment. A full third of delinquent borrowers in the sample received a modification that increased their payments.

Digging deeper to take into account the risk profile of each loan before it was modified, researchers confirmed these trends: homeowners who obtained a rate reduction were about 13 percent less likely to redefault than similar borrowers in similar situations (e.g., type of loan, geography, servicer, loan amount, etc.) who received a traditional modification. Those whose rate reduction was accompanied by a principal reduction were 19 percent less likely to re-default.