Second Chances: Subprime Mortgage Modification and Re-Default

Abstract

Mortgage modifications have become an important component of public interventions designed to reduce foreclosures. In this paper, we examine how the structure of a mortgage modification affects the likelihood that the modified mortgage re-defaults over the next year. Using data on subprime modifications that precede the government’s Home Affordable Modification Program, we focus our attention on those modifications where the borrower was seriously delinquent and the monthly payment was reduced as part of the modification. The average re-default rate over the 12 months following the modification is 56 percent. The data indicate that the re-default rate declines with the magnitude of the reduction in the monthly payment, but also that the re-default rate declines relatively more when the payment reduction is achieved through principal forgiveness as compared to lower interest rates.