Lenders lack financial incentive to modify delinquent loans, study finds

Few delinquent mortgage borrowers receive loan modifications because the practice is not profitable for lenders, according to a study released yesterday by the Federal Reserve Bank of Boston.
The study examined 665,410 loans originated between 2005 and 2007 that were considered “seriously delinquent” because payments were 60 days in arrears.
According to the study, only 3% of borrowers received a modification that reduced their monthly payment. Another 5.5% received a modification that kept the payments the same or increased them because the money owed in arrears was added to the principal balance, the report said.
But the fact that the vast majority of loans — 91.5%— were not modified when in arrears suggests that it’s not a profitable business for the lenders, said Paul Willen, an economist at the bank and one of the co-authors of the report.
The researchers found that about a third of the delinquent borrowers lost their homes to foreclosure.
Another third found a way to pay what they owed without assistance from the lender.
“They got their act together somehow and got a new job or borrowed from relatives,” Mr. Willen said.
“And the rest are in limbo,” he said. “Some are in still in some stage of foreclosure or are still 60 days delinquent.”
Renegotiation of loans exposes the lenders to the risk of giving more lenient terms to a borrower who does not actually need assistance, the report concluded.
Another risk is that the borrower might default even after receiving the loan modification, Mr. Willen said.
“It is possible that that the probabilities the [lenders] are using are wrong,” he said. “But … lenders view [the modifications] as an expensive and not profitable enterprise.”
Even the Department of the Treasury’s Home Affordable Modification Program may not be enough to make the process more attractive to lenders, Mr. Willen said.
And even if the government’s program doubles the number of loan modifications, that still only accounts for a fraction of the borrowers at risk, Mr. Willen said. “The government should provide direct assistance to the borrowers.”
The study examined loans that are held by banks and other private securitization pools.
The data represented about 60% of mortgages originated in the United States between 2005 and 2007, the report said.
The researchers plan to continue the study.

Related Topics: Banking