Lack of Home Equity May Lead To Modification Failure

[Dec 10, 2008.]

 

An article written by Luke Mullins of U.S. News & World Report outlines six reasons recent loan modifications have been defaulting in staggering numbers. According to John Dugan, Comptroller of the Currency, 58 percent of borrowers who received a modification had defaulted within eight months.

The second reason listed in the article is referred to as the "underwater effect".

While loan modifications have reduced monthly payments for some borrowers, they haven’t sufficiently addressed the issue of “negative equity,” where a homeowner owes more on his mortgage than the home is now worth, says Christopher Thornberg, founder of Beacon Economics. “The modifications that they are doing don’t solve the fundamental problem,” Thornberg says. “The fundamental problem is that people’s homes aren’t worth anything close to the amount of debt that they are carrying on the home.”

Many consumers have grown to rely on home equity loans during difficult financial times. For most homeowners, their home equity represented most, if not all, of their net worth. If they had no savings but had a significant cash need, they could simply borrow against their home equity to get by. Job loss, divorce, illness, and injury could all be aided with cash extracted from one's home equity.

Without available home equity to borrow against, some homeowners are uanble to meet their monthly obligations. Given the choice between putting food on the table or making the mortgage payment on a home worth less than what is owed, it is no suprise that so many are going delinquent.

There is no financial incentive to struggle to make a mortgage payment on an asset that appears to have no value.

Even in situations where modifications resulted in reduced monthly mortgage payments, many homeowners have little in the way of a cushion and are easily thrown off track again as soon as they need home repairs, a car breaks down, or a child becomes ill.

Until loan modifications begin to address the "underwater effect", default rates on modifications will continue to be high.

About the Author:

Chris Rocks is the Founder and Executive Director of the Credit Advisory Alliance (CAA), a consumer advocacy group that assists small business owners and consumers overcome debt and credit challenges. He can be contacted by visiting his personal site, GoodCreditLiving.com.

 

About Author:

Chris Rocks is the Regional Director of the National Credit Federation (NCF), a consumer advocacy group that assists small business owners and consumers overcome debt and credit challenges.