OCC and OTS Mortgage Metrics Report

Changes to Monthly Payments Due to Modification

In the previous sections, the report described the various types of modifications and modified loan terms.  This section describes the effect those changes had on monthly principal and interest payments and how those changes in payments affected re-default rates.

This report builds on the sustainability information presented in previous reports to include information on modifications that decrease payments by 20 percent or more, decrease by 10 percent to less than 20 percent, decrease by less than 10 percent, leave payments unchanged, or increase payments.  Of the loans modified between January 1, 2008, and March 31, 2009, 45.5 percent reduced monthly principal and interest payments; 27.5 percent left payments unchanged; and 27.1 percent increased monthly payments.

Loan modifications may result in an increase in monthly payments when borrowers and servicers agree to add past due interest, advances for taxes or insurance, and other fees to the balance of the loans and re-amortize the new balances over the remaining life of the loans.  The interest rate on the loans may or may not be changed in these situations.  Modifications may also result in an increased monthly payment for adjustable rate mortgages about to reset where the interest rate is increased but not by as much as contractually required.

Modifications that increase payments may be appropriate when borrowers experience temporary cash flow or liquidity problems but have reasonable prospects to make the higher payments and repay the debt over time.  In the past, such modifications were done in low volume and were effective loss mitigation strategies.  However, during periods of economic stress, the data showed this strategy can carry additional risk and underscores the importance of verifying, on a case-by-case basis, borrowers' incomes, so that servicers can have confidence that the modifications are likely to be sustainable.

Servicers also modify some loans that leave principal and interest payments unchanged.  One example is in cases where servicers "freeze" the current interest rate and payment instead of allowing the rate and payment to increase to the level otherwise required by the original mortgage contract.

Modifications that result in a decrease in payments occur when servicers elect to lower interest rates, extend the amortization period, or forgive or defer principal.  Reduced payments make loans more affordable and more likely to be sustainable over time.  The lower payments also result in less monthly cash flow and interest income to the mortgage investor, who often compares this reduced cash flow with the potentially greater sustainability of receiving the modified payments over time.

Servicers' modification activities often are dictated by servicing agreements that, in many cases, define the type and the amount of modification action(s) that can be executed.  These pooling and servicing agreements often encouraged the capitalization and recapitalization of missed interest payments, fees, and advances in an attempt to recapture all contractual cash flow and income for the mortgage investor.  Moreover, pooling and servicing agreements tended to allow modifications only for severely delinquent borrowers rather than allow servicers to work with borrowers who are current but facing an imminent default.  Servicers report that recent changes in government and private investor servicing standards provide greater flexibility to structure more effective loan modifications.¹⁷