Loan Mod madness

Good explanation from NYT columnist Floyd Norris on why so few temporary mortgage modifications ever turn permanent. The basic answer, as we've been saying for some time, is that many of the borrowers should never have received loans in the first place. How do you modify something that's faulty to start with? I know it's politically unpopular to suggest that the borrower might be better off renting - but many of them would.

Borrowers can declare their income, and the banks are willing to grant temporary modifications based on those figures, without any evidence to confirm them. But to make a modification permanent, the banks have to see proof of income, and the borrower has to make three monthly payments of the new lower amount. In most cases, those requirements are not being met. The banks, and the government, are soon going to have to decide what to do about borrowers who are making the modified payments but have not provided the documents after repeated efforts to obtain them. Should the banks just take the money and let the preliminary modification turn permanent? Or should they foreclose?

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Chase disclosed in November that nearly a quarter of trial modifications had failed because the borrower did not make even a single payment, and that nearly half had failed to make all three payments required before the modification could become permanent. Of those who had made all three payments, only about a quarter had submitted all the required documents. Updated numbers will be released next week. "It is getting better," David Lowman, the chief executive of Chase's mortgage business, told me this week. But the gains are in contrast to a very low level of compliance.

To determine whether a loan is worth saving, the bank must come up with what the value of those future payments would be (based on assumptions that no one is in much of a position to know). Then the bank compares that number with the price it could get by foreclosing. If the foreclosure price is higher, the loan modification is turned down.

One thing working in borrowers' favor is that foreclosure values are heavily discounted to take into account the delays involved in the process, the costs of maintaining a home until it can be sold and the possibility that property values will continue to fall. In one case I saw, the house was estimated to be worth $227,100, far less than was owed. The present value of the payments to be made under the modified loan was $159,611. modification was nonetheless approved, and the monthly payment fell to $1,004 from $1,877. What made the difference was the bank's conclusion that it would get a present value of just $139,568 from a foreclosure, nearly 40 percent less than the estimated value: the low payments were worth more than the alternative.