If loan modifications are supposed to help borrowers, why are so many going bad?

“Toxic” Terms:

Surprise, surprise, but many lenders have not been modifying mortgages aggressively enough to actually make them affordable to distressed homeowners. Some lenders are in fact modifying mortgages with terms that the borrower could never afford. So it’s not a shock that borrowers are quickly in the same place they were before they modified. Often times, the servicer and/or investor wants to squeeze out as much money as possible from the borrower, believing that foreclosure is inevitable. The modified terms may be more affordable than they were before the modification, but they don’t go far enough.

Other Debt:

Many, if not most borrowers, are behind not only on their mortgage debt, but they are behind on payments to other creditors as well such as credit card companies and student loan providers. These borrowers may feel compelled to use the cash they are saving on their mortgage to pay off their other debts. So essentially, their overall relief—if any—is minimal. Many people no matter what the terms of their modification are will never be able to get caught up until they address the other financial problems they are having.

Negative Equity:

Negative equity—or what’s known as the “underwater effect”—has been a major contributing factor in the high default rate of loan modifications. Most loan modifications do nothing to address the issue of negative equity in which a borrower may owe significantly more on the property than it is actually worth. Many of these borrowers have little incentive to keep their homes because it will take such an incredibly long time for them to be in a positive equity position again. They think, “I’m still underwater on my home. Why bother paying the mortgage?”

Overextended Borrowers:

Many borrowers are simply overextended on their home loan. They may have gotten a loan with a short-term teaser rate, but they really got in over their heads, and bought more home than they could ever afford. Even if the lender significantly reduces their payment, it still may not be enough for them to afford the property.

Moral Hazard:

Some distressed borrowers may be expecting another round of modifications if they default again. There is a “moral hazard”: the borrower may feel that since the modification was negotiated once, the potential to renegotiate exists.

Job Loss:

With unemployment headed into double digits, more and more borrowers are losing their jobs. Once they’ve lost one of their main sources of income, the chances of them being able to afford even a modified mortgage are greatly diminished.