Principal Reduction Most Effective Type of Mod: Amherst
By: Esther Cho
Amherst Securities recently released a report declaring that principal reduction modifications, without question, are the most effective form of modification.
Between three types of modifications – principal, rate, and capitalization – the controversial and much-debated principal reduction mod was found to be the most effective based when it comes to its 12-month re-default rate.
The report, which was co-authored by housing analyst Laurie Goodman, counted principal modifications as mods involving a balance reduction, rate mods involved an interest rate reduction, and a capitalization mod involves neither action and is when the delinquent amount owed gets added to the principal balance without charging the interest rate.
Although the FHFA does not permit Fannie Mae and Freddie Mac to apply principal reduction modifications to their loans, the report revealed that in 2012, principal modifications now account for almost 40 percent of total modifications, up from 25 percent in 2011 and 11 percent in 2010.
For 2011 modifications, the re-default rate after 12 months for principal modifications was 12 percent compared to 23 percent for rate modifications and 30 percent for capitalization modifications, according to the report.
Other factors leading to a successful modification also include more significant payment reductions, modifications made earlier in the delinquency process, and mods that are better tailored to borrower characteristics.
The report backed claims of pay relief as means for a successful mod by pointing to data on 2011 modifications, which showed that mods with pay relief less than or equal to 20 percent had a 12 month re-default rate of 30 percent, while those with pay relief greater than 60 percent had a re-default rate of 12 percent.
Timing – while not everything – was also named as an important factor.
“If a borrower is offered a 30% pay reduction immediately upon becoming delinquent, that person is apt to feel very good about the new modification – he is getting a ‘deal.’ Offering the same modification after a 15 month period of mortgage non-payment-is going to appear less attractive,” the report stated.
In 2011, close to 30 percent of borrowers who were 12 months or more delinquent when modified re-defaulted after about a year of getting modified, while less than 20 percent of those who received a mod while delinquent by two months or less re-defaulted after a 12-month period.
Interestingly, the report notes that the earlier a HAMP mod is completed, the more compensation a servicer receives from Treasury.
For example, if a modification is done for a borrower who is less than 120 days delinquent, Treasury gives the servicer $1,600; for borrowers 120–210 days delinquent, servicers received $1,200; and for borrowers who are 210 days delinquent or more, the servicer gets $400. Prior to this incentive structure introduced in July 2011, servicers once received $1,000 on all completed modifications.
Even with the incentives, the trend over the years is for modifications to be given at higher levels of default. In 2008, about 5 percent of borrowers received modifications when they were 12 months or more delinquent, but in 2012, the number is about 40 percent.
That report noted that FICO credit scores are also related to the success of a modification. In general, borrowers with lower credit scores had higher rates of re-default.
When comparing the effects of a principal modification versus a rate modification on borrowers according to their credit score, the report showed that principal mods were more effective than rate mods for all credit scores.
In 2011, borrowers with FICO scores higher than 740 and with a principal mod had a 12-month re-default rate of about 5 percent while the rate was close to 15 percent for those who received a rate mod.
The number of modifications from borrowers who are receiving their second mod is also rising. In 2008, 5 percent of borrowers had a second mod, while in 2012, 35 percent received second mods.
Although Fannie Mae and Freddie Mac loans are not eligible for principal reduction, the report projects more principal mods to come for two reasons.
Through the $25 billion robo-signing settlement, the five largest banks – Bank of America Corp, J.P. Morgan Chase, Wells Fargo, Citicorp, and Ally Financial – must offer $10 billion in principal reduction for underwater borrowers. Treasury has also tripled its incentives for Principal Reduction Alternative (PRA) mods. PRA was introduced in October 2010 and are offered through HAMP.
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