NEW YORK-As the mortgage industry begins modifying troubled loans in greater numbers, early rounds of modifications are coming in for performance reviews. A handful of analysts and academics who have studied which types of loan modifications work have found that some of the most common changes-reducing or freezing the interest rate and allowing missed payments to be rolled into the balance-often fail to prevent the borrower from defaulting again. These are, of course, high risk loans by definition. But one aspect of some modifications points to why the default issue can rearise so quickly. The addition of arrears and fees to loan balances can actually increase monthly payments, a situation that leaves strapped borrowers no better off from a monthly cash-flow perspective. (Not all lenders charge fees on modifications. Bank of America Corp., for example, waives fees on the Countrywide Financial Corp. loans it is modifying under an agreement with state attorneys general.)
Also, in an environment where house prices are falling, higher loan balances can erode or wipe out a homeowner's equity. "We're going backwards," said Alan White, an assistant professor at Valparaiso University School of Law. "The voluntary modifications are putting people underwater more than they already are and those terms are contributing to the failure rate." Prof. White said he examined the September and October remittance reports on $4 billion of bonds backed by subprime and alternative-A mortgages. Of the loans that were modified, roughly 72% received some form of "negative prepayment" that increased the principal balance. He and others said that the most effective modifications are the ones that reduce principal as well as the interest rate. But principal reduction remains rare.
Rod Dubitsky, the head of Credit Suisse Group's asset-backed securities research division found only two servicers - Ocwen Financial Corp. and Goldman Sachs Group Inc.'s Litton Loan Servicing LP - are doing it in any great numbers.
