Loan Modifications and Redefault Risk: An Examination of Short-Term Impacts

One promising strategy to stem the flood of home foreclosures is to modify mortgage loans so that borrowers can remain in their homes. A primary concern of loan modification efforts, however, is the seemingly high rate of recidivism. In this article, we examine the relationship between redefault rates and different types of loan modifications based on a large sample of recently modified loans. Our findings show that the key component to making modified loans more sustainable, at least in the short run, is that mortgage payments are reduced enough to be truly affordable to the borrowers. The findings also show an even lower likelihood of redefault when the payment reduction is the result of a principal reduction. Unfortunately, our findings also show that to reduce redefault for modified loans that are currently under water (those with significant negative equity), more significant loan restructuring or refinancing may be needed.