By Alan M. White

A distressed homeowner’s chances of being offered a meaningful loan restructuring, as opposed to demands for increased payments to make up past defaults, depends a lot on which mortgage servicing company they happen to be dealing with. As my own research and a recent Credit Suisse report have shown, there is absolutely no consistency in the approach servicers are taking to either the number or the kind of loan modifications they offer. In fact, only two servicers are doing significant numbers of principal reduction mods. This means, among other things, that most servicers could be doing much more.

The Credit Suisse report issued last week, based on extensive data from LoanPerformance, confirms the intuition that an aggressive loan rewrite, involving reductions in principal and making the monthly payment more affordable, is much more likely to result in on-time repayment than the other kind. The other kind of modification involves adding unpaid payments to the principal, reamortizing the loan, and sticking the homeowner with a larger balance and a higher monthly payment. Not surprisingly, these don’t do as well. In fact, after eight months, 80% of the principal reduction modifications are being paid on time, compared with 50% to 60% of the more traditional modifications.

The report also points out that the largest category of modifications recently has been the “rate-freeze” modification. Those involve converting an adjustable-rate mortgage to a fixed rate, to avoid a large payment increase. Unlike the other categories of modifications, 90% of rate-freeze mods are given to homeowners who were previously current, and not surprisingly, most of those borrowers remain current after the modification. If we put aside the rate-freeze deals, and focus on modifications offered to seriously delinquent homeowners, it is clear that writing down principal and/or reducing the monthly payment greatly increase the chances of success.

Now that we the taxpayers will be buying subprime mortgages and related securities, there is a public stake in insuring that servicers use best practices to maximize the number of successful loan modifications, especially when foreclosures produce large losses and further drive down home prices. Treasury, FHFA and the FDIC need to use every tool at their disposal to make principal reductions happen in appropriate cases. There is also a public stake in getting accurate and timely data not only on the numbers of mortgage modifications, but the types of modifications offered and their success and failure rates. In response to the usual bleating about moral hazard, I would point to the fact that the 80% on-time payment rate for homeowners with principal reduction mods is considerably better than the overall on-time payment rate for all subprime mortgages right now.

Want more consumer news? Visit our parent organization, Consumer Reports, for the latest on scams, recalls, and other consumer issues.