Study: Loan Mods Cut Investor Losses
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- Kirk Haverkamp | March 24, 2011
Granting loan modifications on troubled mortgages typically makes better financial sense than going to foreclosure, even if borrowers are likely to redefault, a new study claims.
Reducing monthly payments by 20 percent on distressed mortgages will likely produce better returns for investors than sending those loans to foreclosure, the study claims, even if nearly 80 percent of those loans eventually redefault.
The study, by the Center for Responsible Lending, argues that by pursing foreclosure, banks and other mortgage servicers are often working against the best interests of the investors they represent.
The study was based on an analysis of 1,500 simulations of the Net Present Value (NPV) test used by mortgage servicers to determine whether to grant a loan modification or foreclose. The study argues that granting loan modifications not just in the interest of homeowners, but investors as well.
One of the main reasons loan modifications make sense for investors is the high cost of foreclosure, the study reports. For investors, losses from a foreclosure typically range from 49 percent of the unpaid principal on an prime loan, to as much as 75 percent on a subprime mortgage, according to the study – meaning the investor recoups only 25 percent of the unpaid balance.
Part of the problem, the study notes, is that mortgage servicers and investors they represent often have different financial interests. Mortgage servicers typically don’t own the mortgages they service, instead earning fees for collecting payments and managing the loans on behalf of investors, who benefit from the interest payments but take the loss if the loan goes bad.
“Mortgages in securities often won’t get fixed voluntarily, even when a modification would prevent foreclosure, because banks’ interests are misaligned with the best interests of the investors,” said Bill Frey, president of Greenwich Financial Services and a longtime investor advocate. “It pays for banks to keep mortgages in a state of suspended animation, because they can collect late fees while also protecting second mortgages that are in the bank’s portfolio.”
When mortgages go into foreclosure, the loss is often borne by small banks, insurance companies and pension funds that invest in mortgage securities, according to the study. It says that presently there are 12 homeowners facing the loss of their homes for every one that is in a loan modification.
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