Quick Degree Finder
By Stephanie Armour, USA TODAY
Tens of thousands of financially strapped homeowners who have asked lenders to lower their mortgage payments are instead winding up with higher monthly payments and larger debts on their homes.
Homeowners who were hoping for lower payments are discovering to their dismay that lenders roll late fees, back taxes or other costs into the principal, sometimes turning a difficult payment into an impossible one. That is one reason that many reworked mortgages are sliding back into default.
It's too early to know if this pattern will continue under the Obama administration's $75 billion initiative to get lenders to reduce monthly payments for homeowners struggling to make their mortgages. A total of 360,165 mortgage modifications are now in a three-month trial period under the government's plan announced in March. But the initiative focuses on reducing interest rates rather than cutting principal, which has been found to be one of the most effective modifications for helping homeowners avoid defaulting a second time (known as a "re-default").
Of loans modified from Jan. 1, 2008, through March 31, 2009, monthly payments increased on 27% and were left unchanged on an additional 27.5%, according to a recent report by banking regulators. Many modified mortgages fall delinquent — 25% to 40%, depending on the type of mortgage — often because of homeowners' loss of income or additional outstanding debt, according to a report last month by CreditSights, a financial research firm.
"Payments have gone up …. (and) the payment relief can last for the first few years and then go up (again)," says Alan White, assistant professor of law at the Valparaiso University School of Law in Valparaiso, Ind. He has studied the subprime mortgage situation for 10 years. "(The lenders) focus on today and not on the future." Even under the Obama plan, they don't focus on permanent debt reduction, White says.
The majority of borrowers who've gotten mortgage modifications have seen their overall principal balance go up, according to an analysis by CreditSights and ICP of about 660,000 mortgages modified this year. In about 90% of the modifications, the principal balance after a modification was larger, CreditSights said.
Hit with a 1-2 punch
That's the situation facing Samantha and Steve Jensen. When the couple bought their $550,000 home in Scottsdale, Ariz. six years ago, they thought they'd found the perfect place to raise their three children.
But when their adjustable-rate mortgage reset to a higher rate, they could no longer afford the monthly payments that jumped by about $1,000 a month, to $3,300. So they were relieved when their bank in June offered to modify their mortgage by lowering their interest rate.
Under the modification they were to pay $2,600 a month — but then they discovered they also had unpaid property taxes. Once the bank added taxes to their principal, they say, their monthly mortgage payment grew to $3,500. They got a modification in June and are now two months behind on their mortgage payments and facing possible foreclosure.
"The bank could have done more and reduced our principal," says Samantha, 40, a special education teacher. "You have the anticipation of relief and then you realize it's not going to make it better. It's like being punched in the stomach twice."
How most modifications work
A mortgage modification can take several forms. Lenders may allow borrowers to skip payments and then add the skipped payments to the amount of the loan. They may reduce the interest rate charged, extend the loan term, or reduce the total amount of the loan by forgiving principal.
Many lenders say that reducing principal remains the modification of last resort.
More than 80% of loan modifications that Wells Fargo has done in the past three months have led to lower payments for borrowers, but most involve rate reductions, the bank says. Wells Fargo has done more than 240,000 modifications, and more than 30,000 of those have been under the Obama administration program.
At CitiMortgage, about 92% of modifications involve reducing rates, lengthening terms of the loan, or both. About 8% provide principal reduction.
Providing relief to borrowers is complicated because of the financial interests of the parties on the other side of the loan. Many mortgages are commonly sold to investors, and borrowers' payments are collected by servicers, which may be the original lender or a different company.
Certain types of loans cannot be modified without the investors' approval. Lenders and investors may shy away from reducing a mortgage's principal balance because that requires them to write down the value of the loan. But temporarily reducing interest
payments while adding to the mortgage's principal avoids any loss.
Some research suggests lenders may gain financially if they don't modify a mortgage at all.
According to a paper published this year by the Federal Reserve Bank of Boston, more than 30% of delinquent borrowers fix their situation on their own and are able to pay even if no action is taken.
Another reason lenders might resist modifications is the combined impact of high re-default rates and falling property values in many markets. A lender might calculate that helping a borrower avert foreclosure now only risks a deeper loss if the house goes to foreclosure anyway a year later.
And some lenders say even if they modify loans, so many homeowners are underwater — meaning their homes are worth less than their mortgages — that some borrowers are defaulting on purpose, "walking away" after the lender has spent money and time renegotiating the loan.
"We have customers who can afford the payments but are underwater. They default not because they have to, but because it's better for them," says Jack Shackett, Bank of America's head of credit-loss prevention. "They can act like they want the modification and then they still default, so they've stayed for three to four months in the house for free."
The Obama administration's plan tries to overcome some of these barriers by imposing a three-month trial period during which borrowers must pay the renegotiated mortgage, discouraging them from walking away.
Also, the emphasis under the Obama administration plan is on getting lower monthly payments for homeowners.
Servicers must follow an established process to reduce the monthly payment to no more than 31% of the borrowers' gross monthly income. To do that, lenders will first reduce the interest rate on the loan and then extend the original term of the loan to up to 40 years.
"In the past, modification increased the burdens on borrowers. Under the president's plan, it reduces payments to a meaningful level," says Michael Barr, assistant secretary for financial institutions at Treasury. "Investors and servicers get incentives and are paid only if loans succeed."
Under the program, mortgage holders and investors receive a one-time government payment of $1,500 for each modification agreement completed with borrowers who are current when they begin the program.
Short-term vs. long-term help
Mounting unemployment and loss of income threaten to complicate efforts to prevent foreclosures, even for mortgages that are substantially modified. That's why some banks and economists are pushing for short-term personal loans to the jobless, or a break for several months in making payments.
A recent Federal Reserve Bank of Boston study suggests that to reduce foreclosures, the government should shift its focus from providing mortgage help to directing more financial assistance to those who lose their jobs. The authors say one strategy might be giving loans or grants to individual homeowners for a year or two to help them through difficult periods so they don't lose their homes.
Some lenders are already trying similar tactics on their own. Bank of America is occasionally offering temporary mortgage forgiveness for three to six months in hopes the borrower will find a new job in that time. It is pushing the government to initiate such a program nationwide.
"Our view all along is that that will be a very effective way to address the problem," says Paul Willen, one author on the Federal Reserve study. "A lot of what's being done is a misplaced focus on modest, long-term relief when what they need is fast, short-term, massive relief (due to job loss)."
One such homeowner is Carol Cole, 71, who received a modification in February that cut her payments from more than $3,000 a month to $2,500. That's still $500 more a month than she was paying when she bought her $575,000 house in Santa Rosa Beach, Fla. about five years ago.
With income from her spa business falling, she's worried she'll become delinquent on her mortgage as soon as this winter. Cole has applied for another modification, but she says her bank has told her she has to wait 12 months to qualify for help. Her lender, Bank of America, said it had to deny her request for a further modification because the investor who holds her mortgage does not participate in the government's modification program. However the bank is continuing to pursue the case.
"It's a terrible challenge (making the payments) and I'm trying not to fall behind, but it's going to get to the point I can't make it," Cole says. "This affects your health, your relationships. You don't eat or sleep."