Introduction to Mortgage Modifications

Post date: Apr 13, 2011 4:09:22 AM

The figure below illustrates the way housing markets in the United States work. Borrowers apply for a mortgage from servicers. The servicers sell these mortgages to the Government Sponsored Enterprises (GSEs) who in turn package and sell the mortgages as Mortgage Backed Securities. In many instances, the entire group of people involved in the transaction must come to an agreement on the terms of a modification (this is referred to as a Pooling and Service Agreement).

Government Sponsored Enterprises include Fannie Mae and Freddie Mac (soon to be wound-down). These loans that were packaged and sold were often time poor performing loans. I am not going to use the word subprime, because this is inaccurate. The structure of the loan often times involved payment step-ups (usually in the form of Adjustable Rate Mortgages). The step-ups were often linked to widely followed interest rates.

Many of these mortgagors lost their jobs and faced payment increases. Unemployment benefits could cover a portion of the mortgage payment, but typically mortgagors became delinquent (only around 80% of the mortgage portfolio surveyed by Mortgage Metrics was current in 2008). These people stopped paying (this is what is called delinquency), and in response, banks offered a deal to mortgagors: reduced present payments in exchange for larger future payments. This deal is referred to as a modification.

The government began encouraging these modifications in a series of programs. These will be described later.

Key Question: Were these policies prolonging the Great Recession (see Herkenhoff and Ohanian, forthcoming for a preview of my answer)?