Drawing a Line on Loan Modifications

I've heard a lot of talk about how modifications are so innocuous that nobody wants them.

So I did some digging, exploring the various programs that are being offered. I found that modifications are there for the taking, and highly desirable. But like many things driven by American consumerism, the modification you want may not be the one you can afford.

Here is a sampling of what I found:

• Many servicers offer pre-approved mods and have done so for quite some time. The pre-approved mod simplifies and speeds up the process, minimizing the interaction between the borrower and servicer, which means minimizing the chance documents get lost, calls get dropped and borrowers get burned out. Some servicers are sending notary publics to borrowers' homes to speed up the execution of mod docs. I'm a fan of these programs, because they relieve the burden of servicers who have an overwhelming task in responding to every borrower who should be getting attention.

• Servicers will drop rates on first mortgages, to as low as 6.5 percent from 11 to 12 percent. Investors have a say in whether a rate reduction or a principal write-down is offered and won't easily go below the 6.5 percent threshold. Rates typically are not going below 5 percent.

• Principal write-downs on first mortgages to create affordable payments are becoming more common, and these write-downs aren't always limited by property value. Write-downs on the right loans are investors' way of shoring up their position, by taking a smaller loss today than they would incur if they waited for the loan to foreclose and the property to sell in lousy housing market.

• ARM loan resets are being suspended, and it's being done without a modification or letter agreement with the borrower. Instead, a letters are sent to borrowers asking them to contact the servicer in the event of future hardship. ARM loans are being converted to fixed-rate loans on almost a no-questions-asked basis.

• The government's loan programs are also available, with more modest payment reductions, to help borrowers willing and able to repay their loans but experiencing a hardship and need for assistance. Any opportunity to keep a loan from going bad is forward-thinking, and its impact should not be underestimated.

Much of this is positive news. But there is a dark side to the story.

Mod programs are meant to help a borrower who has encountered hardship get back on his or her financial feet. A mod also is a smart way to get someone out of a loan with unreasonable terms, although the terms may have seemed acceptable when the loan was taken out. I think modifications are legitimate even when the borrower took on too much house, and too much loan, but wants to stay in the home and is willing to commit to repaying a loan that makes sense. A mod, in that case, is a way for the investor and borrower to partner to save the loan and the home from complete loss.

But mod programs are not meant to keep people in homes they simply cannot afford, no matter the loan terms. And mods are not meant to give someone who never intends to repay the loan a fresh start at not repaying it. When we see a very high level of recidivism on mods (according to BlackBox Logic, 22 percent of securitized subprime loans from 2005 have been modified. Of those, 44 percent are 60 days or more delinquent), this reflects the fact that the mod wasn't enough to save that borrower. But we don't need to take that to mean that there should have been a mod big enough to save that borrower.

We're now hearing about borrowers declining modification offers and asking for better terms. Some who don't qualify for certain programs wonder why they don't have a chance at a modification when they are on the brink of losing their homes, while the modification goes to someone else who isn't even behind on a mortgage payment. Borrowers hear about people getting significant principal reductions and are then disappointed to learn the mod they qualify for will only reduce their payments by a few hundred dollars a month.

Of course everyone thinks they should have the $25,000 write-down, instead of a more modest rate reduction! We've just come through a time when everyone thought they needed a great room with a widescreen television in it, a phenomena that Daniel McGinn explores with humor and an eye for the ironic in his 2008 book, House Lust: America's Obsession With Our Homes. Those expectations haven't changed, and they may never change.

My guess is that if there were a subprime mod program, one that gives you more mod than you qualify for, it would be an instant success. What it tells me is that we, in America, are still not ready to give up living beyond our means. Though it is incumbent on the industry to do everything prudently possible to keep homeowners in their homes, it is also up to us raise the standards so that loans, and modified loans, can be trusted to reflect the borrower's willingness and ability to pay.