Despite good news recently in the housing sector, the recovery is still sloggy. A couple of studies released recently have pointed to another festering problem that is certainly holding back a housing rebound: Most borrowers who go through loan modification will default again within 18 months.
Recidivism high for modified loans
American Banker cites a study by TransUnion that researched 600,000 loans that underwent modification from early 2008 to mid-2011 and found that 60% of borrowers became delinquent again within a year and a half, with 42% defaulting within the first year.
This sounds pretty gloomy, particularly since these borrowers will probably wind up in foreclosure. This should not surprise anyone, since many in the pool of 5 million mortgages studied were written before 2008, when stated-income loans reigned supreme. These mortgages, lovingly referred to as "liar's loans," required no income verification on the part of borrowers, and banks were often more than happy to fill in the monthly income line with whatever number was required for swift execution of the paperwork.
It seems apparent that people who didn't qualify for those loans during the salad days of mortgage-making will probably not be able to do so now, after the Great Recession has shredded the economy. Another study offers some good news, however, starring the Obama administration's Housing Affordable Refinance Program.
Principal reduction really works
Another recent study by Amherst Securities Group notes that principal reductions, like those offered by HARP, result in fewer repeat defaults than modifications that consist only of interest rate-reductions or payment-postponement programs. The percentage of defaults in 2011 fell to 12% for those in the first category, with 23% and 30% defaulting in the next two types of modification programs.
This is good news for banks as well as homeowners. Since the government rejiggered the rules so that the originating banks wind up with most of the business, Wells Fargo (NYSE: WFC) and JPMorgan Chase (NYSE: JPM) have emerged victorious in modifying problem loans. Interestingly, Bank of America (NYSE: BAC), whose Countrywide division has become the poster boy for bad mortgage loans, commands less than 8% of the refinance market.
Fool's take
Certainly, the high number of modified loans that are being defaulted upon is distressing and doesn't bode well for the housing recovery. Just when it looked like there might be a light at the end of the tunnel of the foreclosure-dominated market, it now looks as if there could be many more in the pipeline than previously thought.
The HARP program seems to be the only modification program that puts a dent in the recidivism numbers. Some have questioned whether borrowers with liar's loans should be eligible, since they supposedly engaged in fraud to obtain the loan in the first place. Of course, so did the banks -- and they're making a killing in the HARP refinance market. With nearly half of all mortgages written in 2006 classified as liar's loans by Credit Suisse, it seems that very few financial institutions were not involved in the fraud.
The foreclosure mess is a huge headwind for housing, and any tool that helps fix a portion of that problem should be welcomed. A full economic recovery needs a vital housing sector, and I think that the HARP program just might be able to get us there a little sooner.
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