Should Borrowers Share The Blame For So Few Mortgage Modifications?

Over the past year, the prevailing narrative out of Washington has been that banks and mortgage servicers are culpable for preventing foreclosures through mortgage modifications. That view insists that the banks and servicers either don't want to provide modifications or don't have the capacity to meet demand. But in the New York Times today, Floyd Norris has a very interesting article that casts doubt on that theory. His perspective is both interesting and enlightening.

He blames borrowers. According to Norris, a large number of troubled homeowners simply can't afford even heavily revised mortgage terms, or at least can't prove their income can support the lower payments. Norris says:

One reason may be the same one that a lot of bad loans were made in the first place. Borrowers can declare their income, and the banks are willing to grant temporary modifications based on those figures, without any evidence to confirm them.

But to make a modification permanent, the banks have to see proof of income, and the borrower has to make three monthly payments of the new lower amount. In most cases, those requirements are not being met.

This news is troubling. I believe it indicates that a significant portion of the trial modifications that suggested the possibility of real foreclosure mitigation may have been a ruse.

No income verification was one of the central causes of the subprime problem in the first place. In many cases, mortgages were originated without ever requiring borrowers to prove their income. That's pure madness. Yet, the rating agencies stamped AAA-ratings on mortgage-backed securities containing such mortgages even without an attempt to verify income.

So the idea that a modification should only go forward if homeowners can prove their incomes is utterly reasonable. After all, mortgage underwriters should learn from their mistakes. But Norris still somehow questions whether those trial modifications should end in foreclosure or be made permanent anyway -- even without income verification. That's more madness.

Norris also goes on to report that, thus far, those who have been granted trial modifications aren't doing so well according to one of the biggest banks out there -- JP Morgan Chase:

Chase disclosed in November that nearly a quarter of trial modifications had failed because the borrower did not make even a single payment, and that nearly half had failed to make all three payments required before the modification could become permanent.

Of those who had made all three payments, only about a quarter had submitted all the required documents.

25% first-payment defaults is a truly awful statistic. That means a full one-out-of-four borrowers probably never intended to follow through with the revised mortgage contract. And the numbers don't get much better from there -- another 25% failed to make three full payments to qualify for their modification becoming permanent. On top of that, yet another 37.5% failed to provide the necessary documents.

That means nearly 88% of these trial mortgage modifications never had a realistic chance of succeeding. And remember -- even the number of trial modifications granted has been modest.

It doesn't sound like the problem here is a matter of banks not wanting these modifications to succeed so much as borrowers failing to measure up. Either they aren't responsible enough to get their documents in or never really had the income to support the modified payment amount.

In other parts of his article, Norris explains his experience in visiting a mortgage modification call center. As for Washington's complaint that the mortgage re-underwriters were not trying hard enough to modify loans, Norris argues the contrary: "The Chase representatives appeared eager to approve modifications, and were prepared to believe anything people said about their income."

Now don't get me wrong: I am sure there are servicers out there who aren't too keen on modifying mortgages and others who simply refuse to put the infrastructure in place to handle the volume that exists. But as this article makes clear, that's not the whole story. On the other hand, there are borrowers who are failing to qualify for modifications based on the rules put in place by the Obama administration.

This makes a lot of sense: the reason why the permanent mortgage modification numbers have been so unimpressive has more than one cause. Although there are some blameworthy servicers out there, there are also irresponsible borrowers who continue to lie about their incomes or just aren't organized enough to get their documents in.