Mortgage modification, a major boon to delinquent homeowners that has been established since 2007, is now posing a major threat to the overall mortgage market.
Serving as a buffer against foreclosures and defaults, mortgage modifications create permanent changes to the original mortgage through either extending the amortization period, reducing the interest rate, capitalizing the outstanding interest, or outright lowering the amount of the principal owed.
Approximately 8.7 million permanent mortgage modifications have been carried out in the U.S. since the end of 2007.
In its latest report for the first quarter of this year, the U.S. Office of the Comptroller of the Currency (OCC) stated that 21% of the most recently modified loans had re-defaulted within six months. In fact, servicers have had to modify more than 3 million loans between the beginning of 2008 and the end of 2012. For context, servicers are companies that "service" outstanding loans and clip a fee of the initial rate to do so. They are responsible for foreclosures, collecting loan payments, and modifications like the ones mentioned above.
The issue with re-defaults is that given that home prices continue to dwindle, the homeowner no longer holds much incentive to complete their mortgage even after it has been modified. That is, any modifications made to the mortgage to avoid foreclosure will simply be met with further changes down the road as the homeowner sees no sense in paying higher rates. Mortgage servicers have carried out around 9 million permanent modifications remain in their homes, which seems to be deferring the problem and not solving it.
Some people argue that the number of outstanding mortgage modifications is not big enough to be classified as a problem. However, real-estate analyst Keith Jurow argues: "Modifying mortgages as an alternative to foreclosure just kicked the can down the road. It succeeded in bringing these delinquent homeowners into current status. Yet millions of them are re-defaulting on these modified mortgages. The number of re-defaults is increasing relentlessly around the U.S. Worse yet, many re-defaulters are on their second- or third mortgage modification."
It remains to be seen whether the modifications are indicative of a more widespread, sinister housing bubble threat. One thing however, is for sure: if re-defaults continue at this rate, servicers, a key tenet of the housing market and non-agency loans, will have a huge problem on their hands.