Much of the recent public discussion about servicing delinquent mortgages has focused on two extreme outcomes: foreclosures (generally considered undesirable) and loan modifications (often deemed unfeasible).
Less attention has been paid to repayment plans, which let borrowers catch up on arrears over six to 18 months. But as more homeowners have fallen behind, the plans have emerged as an expedient measure for backlogged servicers. Unlike modifications, repayment plans are not restricted by investor requirements.
The problem, some observers say, is that at the end of the repayment plan, the loans often remain delinquent or go into foreclosure. (Sometimes the servicer will put the loan on another plan.) According to these observers, widespread use of repayment plans is keeping serious delinquency rates artificially low. For example, a loan classified as 30 days past due will not progress to the 60-day category as long as it is on a repayment plan; a 60-day delinquency put on a plan will not move to the 90-day category, and so on.
There is disagreement in the industry on whether the masking of delinquencies is an intended effect. But whatever the motivation, the plans have proved in many cases to be a temporary fix.
According to Clayton Fixed Income Services, a large share of subprime loans put in repayment plans last year by a variety of servicers remained delinquent six months later and typically ended in a foreclosure or a short sale — a sale of the home that does not cover the amount remaining due on the mortgage.
Kevin Kanouff, the president of the Clayton Holdings Inc. unit, said servicers are using repayment plans as "one way to reduce default rolls."
Repayment plans are "only a temporary fix for the servicers if they do not fit the borrowers' capabilities to repay," he said. "Eventually the real numbers will come out on bad plans."
However, Rick Smith, the president and chief executive officer of Marix Servicing LLC, a Phoenix start-up owned by the New York hedge fund Marathon Asset Management LLC, said the use of repayment plans "is not an effort to hide default rates but a volume issue.
"Servicers need twice the staff, and in part they just can't manage the volume, so they're giving the borrower every opportunity to become current," Mr. Smith said.
Still, he agreed that repayment plans are not always effective.
"Even in a good market," only 60% of repayment plans will keep a borrower in a home, he said. "Some repayment plans are done as a last-ditch effort, rather than something a borrower truly qualifies for."
It is difficult to determine how many defaulted borrowers are put into repayment plans. Mr. Smith said servicers "are careful about releasing that type of information."
Ron Morgan, the president of strategic default solutions at MortgageHub Inc., a Pleasanton, Calif., software company owned by ISGN Technologies Ltd. in Chennai, India, said repayment plans are "the fastest, quickest cure to get a loan out of default" but the failure rates "are pretty high."
Repayment plans let servicers "recycle the debt and get borrowers off their delinquency reports," he said.
However, such plans help many borrowers who have fallen behind on mortgage payments because of a temporary hardship such as a job loss or hefty health-care bills, he said.
Cheryl Lang, the president of Integrated Mortgage Solutions, a Houston consulting firm, said, "Many times, repayment plans are used to minimize or mask the 90-day-plus category of delinquencies."
But she also acknowledged that the volume of delinquencies is a major problem in the industry because servicers often lack the time to gather all the financial data needed to qualify borrowers for modifications.
The plans let servicers "keep the delinquency rate as low as possible for as long as possible," she said, and "counsel borrowers in the shortest amount of time and get on to the next call."
Steven DeLaney, a managing director and senior research analyst at JMP Group Inc.'s broker-dealer unit, said, "Servicers are only going to do those things if they believe there's a fighting chance the loan won't show up delinquent the next month." However, he agreed that "the delinquency situation is worse than it looks because servicers are masking slow pays — but you can put off the day of reckoning only for so long."
Given the current credit environment and higher delinquencies, repayment plans also help servicers stave off the higher costs of loan modification, which requires underwriting a loan again.
But servicers still must advance principal and interest to investors for the amount a borrower may be in arrears, contributing to higher costs, though they eventually are reimbursed after a foreclosure or short sale.
Michael Walsh, a Chicago mortgage counselor and the owner of ForeclosureFish.com, said servicers are putting many delinquent borrowers into repayment plans before their adjustable-rate mortgages reset and make matters worse.
"It's a very quick and easy fix to the problem. It gets attorneys out of the situation, and it frees up the servicer," said Mr. Walsh, who offers counseling to roughly 200 borrowers a week.
"I'm getting more cooperation from Countrywide, GMAC, and Chase simply because of the sheer number of defaults on their books right now," he said.
Michael Waldron, a lawyer at Weiner Brodsky Sidman Kider PC in Washington, said servicers use repayment plans to keep borrowers from falling further behind.
"The process of offering a repayment plan as a short-term solution buys everyone time," he said.
Diane Pendley, a managing director at Fitch Inc., said some servicers are offering incentives to keep borrowers current such as forgiving some portion of borrowers' arrears as long as they continue paying.
"You're seeing multiple payment plans because, between the push from regulators and consumer groups, servicers know the losses investors are going to face when these loans go to liquidation," Ms. Pendley said.
Duke Olrich, the president and chief executive of DRI Management Systems Inc., a Newport Beach, Calif., provider of default management software, said some servicers are now turning overdue payments into "silent seconds" to be collected by the servicer upon sale of the house or foreclosure.
