HAMP Extended Two More Years -- But Are Loan Modifications Working?

The Obama Administration recently announced that it was extending HAMP for two more years. HAMP was scheduled to end on December 31, 2013 -- now it will continue through 2015.

When HAMP was announced, we were told that HAMP would assist over 3 million homeowners. Four years into the program, we've seen about 1.1. million people receive assistance. We're also discovering that the re-default rates on modified loans can go as high as 47%.

The OCC's latest report indicates that HAMP modifications have performed better than other loan modifications (see page 6). However, 40% of HAMP modifications are delinquent or foreclosed. Congresspersons who oppose HAMP point to this statistic as a reason to discontinue the program -- clearly those "deadbeats" who defaulted once didn't deserve the second chance.

In my experience, there are many other reasons why borrowers re-default. One of the primary reasons is that the modifications do not always include a principal reduction component. I have seen modifications where the princpal balance is twice the value of the home. When a home is that far underwater, there is very little incentive to keep making payments; the borrower is renting from the bank.

Another reason that borrowers re-default is that many loan modifications don't provide very much assistance to the borrower. I have seen loan modfications offered that only reduce the monthly payment by $100 to $200. While the extra money is likely helpful, many borrowers need a deeper discount.

Loan modifications can cure a default and end a mortgage foreclosure lawsuit; however, if a property remains underwater, then the long-term prospects for the loan remain problematic. Many loan modifications tack past-due amounts onto the back end of the loan. This means that, at the end of the loan's life, there is a massive balloon payment due. Normally, this could be solved by refinancing the modfied loan. However, this cannot generally be done without the house first having equity.

In an economy where Wall Street ignores long-term profits for short-term gains, it is no wonder that many homeowners cannot see the long-term sense in paying on an underwater mortgage. This is because there IS no long-term sense in making payments on a long-term mortgage. Home ownership has long been touted as a great investment and a cornerstone of the American Dream and the middle-class lifestyle. Home ownership works great -- when you are steadily building equity. When homes are deep underwater, that investment is largely illusory. It's like the claw game at the arcade; pump in enough dollars, and sooner or later, you'll win a prize. Similarly, a home will eventually regain equity -- in the meantime, however, the borrower is left picking up the tab for the largesse of the mortgage industry.

Let's not fool ourselves. It is easy to snipe at faceless homeowners who are "deadbeats" being "supported by tax payers." We can easily lose sight of the fact that those same people also pay taxes. We can forget that it was the mortgage industry that created the conditions where property values could become an unstable bubble market. In hindsight, that bubble market was easy to create -- after all, the "common knowledge" was that mortgages are a safe investment because property values always go up. The key difference is that property values shouldn't skyrocket -- there should normally be steady growth.

In theory, loan modifications should help stabilize housing prices and keep the market on a path towards recovery. In practice, redefaults on those modified loans create a situation where many loan modifications are simply kicking the can down the road. When the borrower defaults again, the property enters foreclosure and drags local values down. Again.

All of this said, loan modifications can be useful tools that do help homeowners. I've seen some great loan mods with massive principal reductions. I have also seen some awful modifications. Like many things, you cannot condemn all loan mods based on the bad ones. However, it is important to think about loan modifications as part of an overall strategy. Loan modifications can provide the necessary breathing room that allows homeowners to make informed decisions about their financial obligations and future.

At the same time, let's keep an eye on this trend. When the folks over at Naked Capitalism start referring to loan mods as "predatory," you can bet that there's something to it.

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