The Problem with Loan Modifications

Over the past two years, many policymakers have identified loan modifications as key to fighting the mortgage crisis. The rationale for encouraging modifications appears quite simple: foreclosure is expensive for both the borrowers (who lose their home and their credit worthiness) and lenders (who often recover only a fraction of what they are owed). It would therefore seem that loan modifications — reducing payments so that owners can avoid foreclosure — are a potential win-win for both sides.

From that perspective, the slow pace of modifications appears rather mysterious, with potential causes including (a) stupidity on the part of lenders and servicers, (b) flaws in servicing contracts for securitized mortgages, and (c) borrower reluctance to even speak with their lenders.

Both the Bush and Obama administration have initiated a series of policies to encourage modifications, yet results have not lived up to expectations. The Washington Post has a nice article this morning that walks through one of the reasons for this failure. The basic problem is that the argument in favor of loan modifications focuses on only one kind of borrower: those who would make payments with some help but won’t make payments without that help. However, those borrowers are outnumbered by two other types: those who would pay without help and those who won’t pay even with help.

From the lender’s point of view, the economics of loan modification must consider all three types of borrowers. Modifying the loan of someone who would pay anyway is, from the lender’s point of view, a pointless giveaway. And modifying the loan of someone who is going to default anyway is just delaying the inevitable. Delay can be expensive, moreover, in an environment of declining house prices.

The WaPo story is based, in large part, on this recent paper from the Federal Reserve Bank of Boston. The authors summarize their findings as follows:

We document the fact that servicers have been reluctant to renegotiate mortgages since the foreclosure crisis started in 2007, having performed payment-reducing modifications on only about 3 percent of seriously delinquent loans. We show that this reluctance does not result from securitization: servicers renegotiate similarly small fractions of loans that they hold in their portfolios. Our results are robust to different definitions of renegotiation, including the one most likely to be affected by securitization, and to different definitions of delinquency. Our results are strongest in subsamples in which unobserved heterogeneity between portfolio and securitized loans is likely to be small, and for subprime loans. We use a theoretical model to show that redefault risk, the possibility that a borrower will still default despite costly renegotiation, and self-cure risk, the possibility that a seriously delinquent borrower will become current without renegotiation, make renegotiation unattractive to investors.

About Donald Marron 294 Articles

Donald Marron is an economist in the Washington, DC area. He currently speaks, writes, and consults about economic, budget, and financial issues.

From 2002 to early 2009, he served in various senior positions in the White House and Congress including: * Member of the President’s Council of Economic Advisers (CEA) * Acting Director of the Congressional Budget Office (CBO) * Executive Director of Congress’s Joint Economic Committee (JEC)

Before his government service, Donald had a varied career as a professor, consultant, and entrepreneur. In the mid-1990s, he taught economics and finance at the University of Chicago Graduate School of Business. He then spent about a year-and-a-half managing large antitrust cases (e.g., Pepsi vs. Coke) at Charles River Associates in Washington, DC. After that, he took the plunge into the world of new ventures, serving as Chief Financial Officer of a health care software start-up in Austin, TX. After that fascinating experience, he started his career in public service.

Donald received his Ph.D. in Economics from the Massachusetts Institute of Technology and his B.A. in Mathematics a couple miles down the road at Harvard.

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8 Comments on The Problem with Loan Modifications

  1. The “Modification Makes Sense” section is even smaller than it appears because lenders/investors do not really want to own these mortgages and the value of a modified mortgage is currently nil compared to its cash flows.

  2. Instead of a rental payment, let the homeowner make the payment toward the mortgage and the government can cover the difference in a mortgage assistance program which will be repaid over time.

    Here is an example of how it could work.
    • Mr. and Mrs. Z have a mortgage payment of $1,170 ($200,000 loan with 30 year payout at 5.75% interest).
    • The Z’s lose their job and can only pay $470, so the government pays the difference of $700
    • The Z’s remain homeowners and work through their problem. It takes the Z’s 10 months to get back on their feet, the government paid out $7,000 and now the Z’s owe the government.
    • But the government says okay, you can start paying us back in seven years and the payment will be over 10 years at an interest rate of 3%.

    Check out the Mortgage Assistance Program at
    to find out more

  3. They bailed out wall street but kicked homeowners to the curb with no place to live.

    I am trapped in an interest only loan with America’s Servicing Company who obstinately won’t even send me the paperwork. If you are behind on payments they foreclose even IF they agree to a loan modification. They are unprofessional and unscrupulous. The government is doing NOTHING BUT….

    They bailed out wall street and kicked homeowners to the curb with no place to live. They are taxing the middle class to death. We have been abandoned.

    It is obvious this administration will do ANYTHING to help big business but will not help hard working Americans who want to stay in their homes and make their payments. For one thing the 31% of gross rule is absurd. For those in trouble, especially singles, payments may already be at 31%. This is the case for me. But the catch is I’m single so I get taxed to the max eroding my gross salary. MY PAYMENT IS 55% OF MY NET but they don’t take that into consideration.

    The servicing companies get kickbacks for loan mods. The banks get bailed out. The TARP benefited everyone but the homeowner. President Obama has let us down and now he wants us to pay for healthcare.I would consider it as a good idea but with facing homelessnes how can I consider a new tax boondoggle?

    Obama could have used TARP funds to bailout homeowners but stiff armed us away with complicated rules and regulations that no one can qualify for. And, now I read this article about the FICO score ding for a loan mod. I’m crying my eyes out. I’m too old to start over and the stress is killing me.

    I started a blog to collect stories to print out and mail to Obama. I figure with a big pile, he would pay attention.

    Go to:

    and post your story.

    Thank you.

    • Why should the government bail out people who have made stupid mistakes? Only an idiot would choose an interest only loan. Only someone who can’t afford a conventional loan does that. If you couldn’t afford a conventional loan, you couldn’t afford to buy a house in the first place and the only one at fault is you. This is your responsibility, not the governments’. As far as the government ‘bailouts’, get an education – the ‘bailouts’ were loans. Loans that yielded billions of dollars in interest back into this country. If the gov didn’t bail out the banks, they would have had to pay all the FICA claims from individuals costing the country trillions. Trillions that would not have made any interest back to the country. Understand how that works? Know what FICA means? You CHOSE an interest only loan and the one who put you in that ‘trap’ is you. Take responsibility for yourself. I, as a taxpayer, am not interested in bailing you out. That is who really does the bailouts. ‘Government’ bailouts come from taxpayer money. Bailing out the banks gave money back to the country in interest, bailing out you would be a loss. Get it?

  4. Thanks for this – I’ve been working hard to get squared away with my loan modification process and trying to get a good understanding of everything I need to have in order. It’s been stressful but I’ve found some great resources like this and am grateful.

  5. Yes im posting this blog on America Servicing Company, they just foreclosed on my home after trying for 5 months to get a modification that thepresident promised. I even set up a budget with CCCS and they submitted it. I lost my wife 4 years ago to cancer she was a school teacher and last year i was laid off and lost over 17,000.00 and ASC even took 3 post dated checks and gave me comformation numbers that i still have. Then when the money wasn't taken from my account I called and ask why they said I missed my payment before the first check was to be deducted from my account, and the agent said i didnt need to make that payment. It makes no sence. Thanks

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