To ensure that lenders or servicers act responsibly in helping to prevent foreclosure for troubled borrowers, some state governments are entering into agreements directly with the servicers or are strengthening regulations to enable more borrowers to get long-term and sustainable loan modifications.

Loan modifications fall into two main categories. Modifications can reduce the size of monthly payments for a homeowner, either through an interest rate reduction, principal reduction, or extension of the term of the loan.  These modifications are sometimes called concessionary. Concessionary modifications provide long-term relief and are the most effective at preventing foreclosure in most cases (Adelino, Gerardi, and Willen, 2009). 

Other loan modifications provide temporary relief to the homeowner – temporary forbearance, for example, allows the homeowner to miss one or more payments during a time of hardship. However, the missed payments are recapitalized into the balance of the loan, increasing payments in the long run.  This type of modification is only effective is limited circumstances in which the borrower has a temporary hardship and an ongoing ability to afford higher monthly payments in the near future.

One of the most comprehensive and large scale efforts to encourage successful loan workouts is the Ohio Compact to Preserve Homeownership. The Compact, signed by the governor in April 2008, establishes an agreement between the state and nine subprime mortgage loan servicers to use "good faith" efforts to keep families in their homes. The Compact is based on the following six principles: Engage in a substantial and large-scale loan modification effort for adjustable rate mortgage resets and subprime mortgages. Identify, evaluate and make good faith attempts to contact at-risk or defaulting borrowers as soon as possible. Modify loans to the extent permissible within existing fiduciary, contractual or other legal obligations and in accordance with prudent mortgage lending and servicing practices. Create incentives for staff and foreclosure counsel to modify loans rather than foreclose. Report progress to the Ohio Department of Commerce. Enter into a non-binding agreement with the State for some defined period of time. (The agreements extend to June 30, 2009.)

Chris Callis Photography, courtesy of Common Ground

Click here to leave this site and learn more about the Compact to Preserve Homeownership.

In a measure to increase the pace of loan workouts and prevent foreclosures for troubled borrowers, state officials in Massachusetts have organized workshops to bring lenders and borrowers together and provide opportunities for individual, face-to-face counseling sessions. These workshops, targeted for areas with high rates of foreclosure, grew out of concerns expressed by housing counselors and borrowers that lenders and servicers were not easily accessible when they sought assistance. It is worth noting that while loan modifications may help many families, they are not a panacea. Since many predatory lending practices provided mortgages without requiring verification of the borrowers' income, many families got home mortgages they could not afford in the first place and would be unable to afford with any reasonable level of loan modification. According to the Office of Comptroller of the Currency, families that received loan modifications have experienced high rates of re-default -- suggesting that loan modification merely delays foreclosure. A policy alternative in some cases could be to use intensive, short-term aid to keep families in their homes. (See resource box at left for more on the impact of modifications.) Additionally, policies that aim to ease the process of loan modifications or mortgage refinance to keep families in their homes must be carefully crafted to ensure they are feasible for borrowers, lenders, and servicers.  This may entail offering a package of programs to help with temporary financial crises, unaffordable mortgage terms, and negative equity that impedes refinance -- all while considering sound underwriting standards and servicers' obligations to investors. Assistance through the federal Making Home Affordable program includes loan modifications, refinance, and, more recently, emergency assistance loans. Between April 2009 and January 2011, nearly 1.5 million trial modifications were started under the Home Affordable Modification Program (HAMP).  Permanent modifications, however, have faced more challenges.  The program may benefit from a critical analysis of the impediments to stronger participation.  Click here to leave this site and learn more about Making Home Affordable.

Loan Modifications and Redefault Risk: An Examination of Short-term Impact While loan modification can be a useful foreclosure prevention tool, some researchers have found high redefault rates within a short period of time following modification. A March 2009 working paper issued by the Center for Community Capital at the University of North Carolina at Chapel Hill helps to uncover why this may be the case by analyzing the impact of different types of loan modifications on redefault risk. Authors of the report Robert Quercia, Lei Ding, and Janneke Ratcliffe, draw from a national sample of nearly 10,000 modified mortgage loans, including those that were already past due and those that remained current but at imminent risk of default. The most common modifications found in the sample included interest rate reductions in which the principal remained the same or increased slightly (53 percent), and traditional modifications, in which delinquent payments, unpaid interest, and fees are added to the unpaid principal (39 percent) -- an intervention which typically leads to higher monthly payments. Not surprisingly, findings indicate that the risk of redefault is substantially reduced when mortgage payments are reduced enough to be affordable to borrowers, through extending the loan term, reducing the interest rate, and particularly when accompanied by a reduction in the principal. Additionally, the authors find that early intervention yields better results. Borrowers who were current on their payments were much less likely to redefault than borrowers who received modifications after missing one or more payments. View the full report here [PDF].

You are currently reading: Collaborate with lenders and servicers to obtain better terms for existing borrowers Other pages in this section: Offer a range of suitable refinancing products and emergency loans   Skip to: Counseling, Mediation and Legal Assistance Linking homeowners with both outside experts and neutral third parties can help families understand their options and reach a resolution that avoids foreclosure and its related costs for families, communities, and mortgage servicers. Extending the Foreclosure Timeline Extending the process of home foreclosure through a temporary moratorium on foreclosure or by increasing the notice period required before a foreclosure may take place may allow homeowners additional time to reduce the financial damage of foreclosure. Reduce the Risk of Foreclosures in the Future Foreclosure risks are often identifiable and preventable many years in advance. Governments can counter these risks through targeted outreach, regulations to prohibit the riskiest loans, and enhanced consumer awareness to help families make better mortgage decisions. Click here for more resources on preventing foreclosure.