Redefault Risk in the Aftermath of the Mortgage Crisis: Why Did Modifications Improve More than Self-Cures?

Abstract

This paper examines change in the redefault rate of delinquent mortgage borrowers granted a loan modification during the 2008–2011 period, in comparison to similarly situated self-cured borrowers. We document a larger decline in the redefault rate of modified relative to self-cured loans, controlling for differences in their observable characteristics using a propensity score matching process. We attribute the relatively rapid improvement in performance of the modified loans in part to an increasing share of principal-reduction modifications and to increasingly generous interest rate reductions. Even after accounting for these and other factors, we still observe a larger decline in the redefault rate for modifications. This higher success rate for later modification cohorts likely reflects servicer “learning-by-doing.” Overall, our findings are supportive of public policy that encourages mortgage modification, which has proved to be successful in allowing distressed homeowners to keep their homes and reducing losses to lending institutions.