C. Modified Loan Performance, by Change in Monthly Payments

First Quarter 2009

The reasons borrowers re-default on modified loans at such a high rate remain unclear but likely result from a combination of such factors as declining property values, reduced income due to underemployment or unemployment, excessive borrower leverage, issues affecting consumer willingness to pay, and poor initial underwriting.  The stage of delinquency in which a modification is implemented is another key driver—the more serious the delinquency, the less likely the borrower will remain current after modification.  None of these factors can be easily captured in the type of data gathered by this report.

The data presented in this section of the report consistently show that re-default rates were lowest and payments most sustainable for modifications that reduced monthly payments.  Re-defaults were highest for modifications that resulted in no change or an increase in the monthly payment.  Further, the greater the percentage decrease in the monthly payment, the lower the subsequent rate of re-default.  However, the data also showed that re-default rates were higher for modifications that left monthly payments unchanged than for modifications that increased monthly payments.  The reasons for this apparent anomaly are unclear.  According to servicers, one explanation is that modifications in which the payments were unchanged often resulted from freezing the interest rate on adjustable rate mortgages prior to the loans resetting to higher payments.  While the servicers have determined that these borrowers were at risk of imminent default, the action to freeze the rate and payment was often taken as part of a systemic program that did not involve a full assessment of the borrowers' capacity to continue making their payments.

Modified loan performance included in this report supported the premise that lower payments produce more sustainable modifications, repeating the finding in the fourth quarter report.  While delinquencies increased over time for all categories, delinquencies resulting in payments reduced by 20 percent or more were well below delinquencies for categories involving payments that were unchanged or increased.  This was true across all vintages.  For servicers and investors, determining the optimal type of modification often requires weighing a combination of loan terms that reduce monthly principal and interest payments against the potential for longer term sustainability of the payments.

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