Financially strapped homeowners who are close to foreclosure may want to face the music now rather than continuing to struggle with their monthly payments. There's a high probability of losing the house anyway, even with the government's help.
According to a new report, people who take advantage of a key federal program to modify their mortgages in an effort to save their homes are defaulting "at an alarming rate."
The report from the special inspector general for the Treasury Department's Troubled Asset Relief Program doesn't say why an inordinately high percentage of owners who take part in the Home Affordable Modification Program, or HAMP, are unable to maintain their loan modifications. The report only says that the longer owners remain in the program, the more likely they are to default again.
Even with permanently reduced loan payments, the number of owners who are "redefaulting" is rising, the inspector general says.
At the end of the first quarter of 2013, the report found, nearly half of the oldest of the HAMP modifications, from the third and fourth quarters of 2009, are going back into default.
Specifically, 46 percent of the HAMP mods made in the third quarter of '09 redefaulted and 39 percent flunked out in the fourth quarter. Even mods from 2010 had high failure rates, ranging up to nearly 38 percent, the report says.
As of March 31, of the 1.28 million owners whose loans were modified under HAMP, more than 312,000 have gone into default again. And when that happens, the consequences are severe.
Owners who cannot sustain their reworked loans and fall out of HAMP are left with the terms of the original mortgage. And as such, they are responsible for making up the difference between the original loan payment and the lower HAMP loan payment.
Not only can the back payment be substantial, the inspector general advises, but already-distressed owners can be hit with late fees on both the principal and interest that weren't paid during the modification period.
In some instances, the report cautions, redefaulting borrowers can end up owing more than they did before their loans were modified.
The Obama administration's signature housing support program, HAMP was created in 2009 to help owners avoid preventable foreclosure by encouraging the companies which administer their mortgages -- so-called loan "servicers" -- to find ways to lower their payments.
Under the program, which was recently extended until Jan. 1, 2016, borrowers with loans made prior to 2009 whose monthly payments for principal, interest, taxes and insurance are more than 31 percent of their gross income are eligible. Generally, servicers reduce the borrower's interest rate or extend the loan term to bring the payment down to an affordable and sustainable level.
As a last resort, but only with the agreement of the investor that owns the loan and is the ultimate recipient of the principal and interest you pay every month, servicers may also forgive some of the amount still owed on the mortgage.
But HAMP doesn't subsidize troubled borrowers. Rather, it provides financial incentives to mortgage servicers that work with borrowers. More than $4 billion of the $7.3 billion in federal funds spent on housing support programs during the housing crisis was spent under HAMP alone.
That raises the question of whether some servicers may be modifying loans they know will eventually fail anyway just to earn fees from Uncle Sam. No one seems to have addressed that issue. But previous research discovered some interesting findings.
For example, a study a few years back from the Federal Reserve Bank of New York found that, pre-HAMP, servicers focused on particularly risky borrowers with lower credit scores, higher debt-to-income ratios and loans with higher original loan-to-value ratios. Thus, the people most likely to fail with or without some kind of relief.
The New York Fed also found that the greater the payment reduction, the less the rate of recidivism. But many loan mods don't lower the payment. Rather, many result in higher payments and higher balances because the payments owed plus any penalties and fees are added to the outstanding balance without changing other terms of the loan.
On the other hand, the study found that the lowest redefault rates occurred when the payment reduction was paired with principal reduction. In other words, the servicer agreed to forgive some of what was owed. When their principal is reduced, the study found, problematic borrowers are four times less likely to default again.
Other studies from the University of North Carolina and the Boston and Atlanta Federal Reserve Banks had similar findings: There's a high correlation between redefaulting and loan mods in which your payments are stretched out and your debt is deferred -- but not reduced.
So the message for underwater borrowers considering a loan modification is this: Unless your servicer offers to rework your loan in such a way that you no longer owe more than the house is worth, think hard about what you are doing.
Is there a real chance you can save your house? Or are you merely putting off the inevitable?