Law Review: Farrell, Bhagat, Ganong & Noel- Mortgage Modifications after the Great Recession: New Evidence and Implications for Policy

Preliminary Comment: This is a study commissioned by the J.P. Morgan Chase & Co. Institute, so not a bunch of wooly-headed, bleeding heart academics. That even it finds tremendous utility in loan modification programs, should not be taken lightly. Abstract: In the aftermath of the Great Recession, various mortgage modification programs were introduced to help homeowners struggling to make their monthly mortgage payments remain in their homes. This article uses mortgage data at the individual borrower level, joined to credit card spending and deposit account data, to investigate the relative importance of changes in monthly mortgage payments and long-term mortgage debt on default and consumption. It first quantifies the variation in payment reduction offered by these modification programs and then use the variation in payment and principal reduction experienced by program recipients to estimate the impact of payment and principal reduction on default and consumption. First, it finds that payment reduction for borrowers with similar payment burdens varied by two to three times across different modification programs. Borrowers with a high mortgage payment to- income (PTI) ratio received more than twice the payment reduction from HAMP compared to the GSE program. Borrowers with a low mortgage PTI ratio received three times the payment reduction from the GSE program compared to HAMP. Second, a 10 percent mortgage payment reduction reduced default rates by 22 percent. Third, for borrowers who remained underwater, mortgage principal reduction had no effect on default. This suggests that “strategic default” was not the primary driver of default decisions for these underwater borrowers. Fourth, for borrowers who remained underwater, mortgage principal reduction had no effect on consumption. Finally, default was correlated with income loss, regardless of debt-to-income ratio or home equity. Mortgage default closely followed a substantial drop in income. This pattern held regardless of pre-modification mortgage PTI or loan-to-value ratio, suggesting that it was an income shock rather than a high payment burden or negative home equity that triggered default. These findings suggest that mortgage modification programs that are designed to target substantial payment reduction will be most effective at reducing mortgage default rates. Modification programs designed to reach affordability targets based on debt-to-income measures without regard to payment reduction or target a specific LTV ratio while leaving borrowers underwater may be less effective at reducing defaults. Furthermore, policies that help borrowers establish and maintain a suitable cash buffer that can be used to offset an income shock could be an effective tool to prevent mortgage default. Both high and low mortgage PTI borrowers experienced a similar income drop just prior to default, suggesting that even among those borrowers with “unaffordable” mortgages, it was a drop in income rather than a high level of payment burden that triggered default. Commentary: The conclusion that it is the monthly payment that matters not the principal balance on the loan should be obvious to most Chapter 13 debtor’s attorneys. Borrowers want to keep their homes, not merely as assets, but because that’s where they live and where their memories are. Getting a lower monthly payment lets them keep their home. That someone pays more over time, due to recapitalized balances, is less important. Borrowers know instinctively that John Maynard Keynes was right that “in the long run we are all dead.” For a copy of the article , please see: Mortgage Modifications after the Great Recession New Evidence and Implications for Policy