When are Modifications of Securitized Loans Beneficial to Investors?

Abstract

Despite loan modification being widely discussed as an alternative to foreclosure, little research has focused on quantifying its effect on loan performance. I quantify the effects of additional modifications made early in the recent housing crisis by exploiting exogenous variation in the incentives to modify securitized non-agency loans. An additional modification reduces loan losses by 40% relative to the average loss, which suggests that the marginal benefit of modification likely exceeded the marginal cost. Consistent with theory, modifications are especially beneficial when borrowers are less likely to return to current status without help and when foreclosure losses are higher.