By: Car­rie Bay 08/24/2010

Accord­ing to a new report from state attor­neys gen­eral and bank super­vi­sors from across the coun­try, more than 60 per­cent of home­own­ers with seri­ously delin­quent loans are still not involved in any form of loss mit­i­ga­tion with their ser­vicer.   The ratio is dis­con­cert­ing con­sid­er­ing the group also found that one of ser­vicers’ pri­mary loss mit­i­ga­tion options today, loan mod­i­fi­ca­tions, are result­ing in sig­nif­i­cant pay­ment reduc­tions with fewer redefaults.

The State Fore­clo­sure Pre­ven­tion Work­ing Group says loans mod­i­fied in 2009 are 40 to 50 per­cent less likely to be seri­ously delin­quent six months after mod­i­fi­ca­tion than loans mod­i­fied at the same time in 2008.

“This improve­ment in loan mod­i­fi­ca­tion per­for­mance sug­gests that dire pre­dic­tions of high rede­fault rates may not come true,” the group said in a paper released Tues­day. “This pos­i­tive trend sug­gests that increased use of mod­i­fi­ca­tions result­ing in sig­nif­i­cant pay­ment reduc­tion has suc­ceeded in cre­at­ing more sus­tain­able loan modifications.”

The con­sor­tium of state reg­u­la­tors and chief attor­neys also found that recent mod­i­fi­ca­tions that sig­nif­i­cantly reduce the prin­ci­pal bal­ance of the loan have a lower rate of rede­fault com­pared to loan mod­i­fi­ca­tions over­all, sug­gest­ing that ser­vicers should strate­gi­cally increase their use of prin­ci­pal reduc­tion mod­i­fi­ca­tions to max­i­mize prospects for suc­cess.  Prin­ci­pal write­downs, though, have been slow in find­ing their way into the mod equa­tion. The group’s study shows that only one in five mod­i­fi­ca­tions reduce the loan prin­ci­pal, and in fact, some 70 per­cent actu­ally increase the loan amount by adding ser­vic­ing charges and late pay­ments to the loan balance.

The government’s Home Afford­able Mod­i­fi­ca­tion Pro­gram (HAMP) recently intro­duced a prin­ci­pal reduc­tion alter­na­tive to its stan­dard water­fall to give ser­vicers the option of pri­or­i­tiz­ing the reduc­tion of prin­ci­pal, but the state group says “the optional nature of this alter­na­tive and its inap­plic­a­bil­ity to GSE loans will likely sig­nif­i­cantly limit its impact in the HAMP program.”

Three years into the fore­clo­sure cri­sis, with just over a third of dis­tressed home­own­ers work­ing with their servicer’s loss mit­i­ga­tion depart­ments, the State Work­ing Group says it antic­i­pates hun­dreds of thou­sands of fore­clo­sures will occur later this year unless improve­ments are made in fore­clo­sure pre­ven­tion efforts.

“The report cer­tainly indi­cates there are pos­i­tive devel­op­ments with regard to loan mod­i­fi­ca­tions,” said Neil Mil­ner, pres­i­dent and CEO of the Con­fer­ence of State Bank Super­vi­sors and a mem­ber of the Fore­clo­sure Pre­ven­tion Work­ing Group.  Mil­ner added, “How­ever, there is still a tremen­dous amount of work to be done to pre­vent unnec­es­sary fore­clo­sures. Ser­vicers must con­tinue to per­form mean­ing­ful out­reach to those home­own­ers who are seri­ously delin­quent and to per­form mod­i­fi­ca­tions with sig­nif­i­cant prin­ci­pal reduction