When a mortgage servicer modifies the loan of a distressed homeowner, chances are 50-50 that they'll redefault, according to a 2010 review of the sector from credit rating agency DBRS
"The 50% redefault rate on modifications continues to be staggering given the income verifications and trial modifications being done by most servicers," states the report.
However, structured finance analysts Claire Mezzanotte and Kathleen Tillwitz find some modification strategies are more effective than others in curing borrower delinquency.
According to DBRS, mortgage servicers implemented 421,322 loan modifications in 2008, 587,500 in 2009 and 497,203 in the first two quarters of 2010, for a total of 1.5 million loan modifications during this period. The firm also expects this number to pick up in 2011
"We are going to see the U.S. government calling for large-scale loan modifications in 2011. However, since most of the delinquent subprime product has already been modified, we expect to see higher modification rates in other products such as option ARMs."
Before putting such an action into play, the report suggests that the government develop a clear strategy for approaching mortgage modification to avoid recidivism. Some types of modifications, they say, do much better than others.
Modifications that reduced borrowers’ monthly payments by 10% or more performed significantly better than modifications that reduced payments less than 10%, increased the payments or left the payments unchanged. For example, of the 794,686 mortgage modifications that reduced payments by 10% or more, 59% were current and performing at the end of the second quarter, compared with 33% of modifications that reduced payments less than 10% (see chart below).
"As a result, DBRS expects modifications that reduce rates and extend terms will continue to be the preferred loss mitigation strategy for many servicers during 2011," Mezzanote and Tillwitz conclude.
Write to Jacob Gaffney
Follow him on Twitter @JacobGaffney