Last year, more than two million Americans lost their homes to foreclosure. This year, that number is expected to be even higher. Foreclosure takes a huge toll on homeowners and their families, and sends shockwaves throughout the economy. Yet since the start of the recession in 2007, more than five million homes have been taken back by lenders. The Center for Responsible Lending (CRL) estimates that as many as 13 million more homes could fall into foreclosure over the next five years.
To combat the foreclosure epidemic, the Obama Administration created the Home Affordable Modification Program (HAMP) last February. As part of this program, the Treasury Department plans to spend up to $75 billion in financing mortgage "modifications" for struggling homeowners.
The modification process changes the terms of the mortgage with the aim of making it more affordable, typically by reducing a borrower's interest rate, lowering his monthly payment, or waiving or reducing past charges. Unfortunately, HAMP has had less than stellar results.
Since the program began, more than three million homeowners have become eligible for assistance. In turn, mortgage servicers have reached out to these borrowers, initiating the modification process. Roughly 760,000 homeowners have received loan modifications on a trial basis. But just 31,000 modifications have been made permanent.
That's a success rate of just one percent. This means that up to 99 percent of eligible homeowners struggling with their mortgage payments have been unable thus far to modify their loans.
A big reason for HAMP's limited success is that the government is suffocating banks with counterproductive accounting rules. Under current law, if a bank modifies a mortgage, it must record the write-down as an expense on its books. For example, if a homeowner's monthly mortgage payment is reduced by $400 per month for 24 months, the bank has to report that it "lost" $9,600 ($400 times 24 months).
The bank, though, didn't lose any money—it's still scheduled to receive the totality of the loan principal, just less interest.
This rule, for obvious reasons, makes banks reluctant to modify. They don't want to take the "loss," which can get very big for larger mortgages with long modified periods. So there's a huge financial disincentive to offer modification.
The incentives are misaligned elsewhere, as well. Mortgages are often sold by the original lender to a third-party investor. Problem is it's often not in the interest of that outside firm to modify the original loan. In fact, mortgage servicers get additional fees if a home forecloses. Similarly, if a mortgage has been folded in with other loans as part of a larger financial device, such as a mortgage-backed security, modification could reduce the monthly cash stream that device generates.
Another obstacle comes from auditors and regulators, who are imposing an ever-increasing load of paperwork on customers and banks looking to modify. In many cases, there are more forms needed to modify a loan than to get a mortgage in the first place.
Finally, regulators haven't done enough to protect banks from "strategic defaulters"—that is, homeowners who aren't facing financial difficulty, but purposely underpay (or stop paying) their mortgages in the hopes of getting a modification. Strategic defaulters suck away bank resources and attention, making it that much harder to service people facing true hardship.
At ING Direct, we have over 2,500 modified mortgages on our books. And our re-default rate for loans that were modified six months ago or more is eight percent—substantially lower than the average for government-guaranteed loans of 44 percent to 53 percent and the overall industry average of 25 percent.
We, like other banks, are doing our best to keep people in their homes. But the government has to help—not by passing out more dollars, but by bringing some common sense to the rules of the game.
The Treasury Department is aiming for three million to four million permanent mortgage modifications by 2012. To get anywhere close to that number—and to prevent this country from sliding even deeper into a recession—regulators need to modify the modification process.
This article appears printed with permission ING Direct and originally appeared in the Opinion column of the Jan. 20, 2010 edition of The Wall Street Journal.
Arkadi Kuhlmann is chairman and president of ING Direct USA. Prior to ING, Arkadi's experience includes both high-level corporate and academic positions. He served as president of North American Trust and chief executive officer of Deak International Inc. and held various executive positions at the Royal Bank of Canada. His academic experience includes teaching at the American Graduate School of International Management (Thunderbird) in Phoenix, Ariz., where he was a professor of international finance and investment banking.