Of the myriad facets within our insipid bailout program, the least effective subset is that of the loan modification, as described recently by Federal Housing Finance Agency (FHFA) Director James B. Lockhart.
I say “is” and not “has to be” because its failure is already evident… we just have too much political inertia to change course.
Now, before judging this post as too harsh, first understand this: there is a huge distinction between “loan refinances” and “loan modifications”.
Refinances are for folks who can:
- Truly afford the new terms, AND…
- Pony up good credit worth defending.
I am all for refinances where, balances are slashed by lenders, rates are subsidized down to 2%, and to some extent, new amortization schedules that go out to 40 years (though the 40yr thing helps lenders more than the borrowers). This is where our government can make a difference.
And while this model in which consumers can directly refinance with their loan servicing company, temporarily eliminates any revenue I could personally derive from executing refinances as a real estate broker, I’m all about separating commission from advice. And while banks are giving free money away, the best advice I can give anyone who will listen is to help bring this proactive servicer-to-consumer model mainstream.
Now, modifications on the other hand (as opposed to refi’s), are for people who have already missed their payments, and this reactive model is doomed before it starts. Unless the propensity to repay can be demonstrated with a clean credit history, then like the Seinfeld sandwich guy would say…”no principal or rate reduction for you!”
Now personally, I don’t blame the “entitlement crowd” too much for feeling entitled, because if you extend an undeserved benefit to an otherwise hardworking person and then take that benefit away, of course they are going to get salty.
Nor, by the way, do I blame investors for getting fat while underwriting these loans in the first place. Who really is so naïve as to think that incentives for the common good will match up to incentives for individual gain anyway?
But I do blame in advance, the pundits being pressured to “do something” who will pave a new lane on this economic freeway and then act surprised when it gets jammed with more traffic.
Here is the point: the entitlement crowd could not afford the old payment… and they can not afford the new payment… and even if they could afford the new payment, they will not be able to afford it the first chance they get.
Am I being ruthless? You bet I am… because while the rest of us see our own income decreasing, we still keep paying our bills. And now we get to pay more taxes on the meager income we do make to repay the mess the entitlement crowd helped make.
You know why? Because we still have a credit profile to defend.
If we offer loan modifications to people who have already destroyed their credit, thereby killing the integrity of the fundamental method by which we measure credit worthiness, then we not only reward the people who are undeserving… but we also provide an unprecedented incentive for well intentioned consumers to just stop carrying their burdens.
Well I guess not unprecedented, if we count healthcare… but I digress.
If I tell you that 50% of all loan modifications previously executed… are already in default… would you believe me? What if I tell you this statistic is four months old!!
Once the credit is damaged there is NO INCENTIVE to make payments on a depreciating asset while the opportunity cost of renting is cheaper. If values continue to decrease (and they will) then the modificationee will do the wrong thing… again. Because that is what they do.
If it were so simple to fix things this way, then how about the next time there is a traffic jam on the freeway, we all just hit the gas at the same time? Are you going to trust the car in front of you?