## Resolving Residential Mortgage Distress: Time to Modify

_IMF Blog, March 11, 2015_

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## Bibliographic details
- Authors: Jochen Andritzky
- Published: March 11, 2015

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### Overview
- Housing crises with high mortgage debt can create a vicious circle: falling housing prices → reduced household wealth → lower consumption → deeper economic slowdown → more mortgage defaults.
- A new IMF Working Paper compares housing crises and policy responses in Iceland, Ireland, Spain, and the United States and argues for a two-stage approach: temporary debt service relief during the crisis followed by durable loan modifications in the recovery.

### Why policymakers worry about mortgage distress
- Housing busts and high mortgage debt can amplify initial shocks, for example through forced home sales flooding property markets and depressing prices.
- This negative feedback affected Iceland, Ireland, Spain, and the United States with varying intensity.
- Prevention of boom-bust cycles is preferable, but widespread mortgage default requires crisis-resolution strategies.
- There is no “one-size-fits-all” solution; country-specific factors and the stage of recovery matter.

### Providing breathing space with temporary forbearance
- Forbearance: lenders offered debt service relief (e.g., reducing mortgage payments to interest only for a limited time).
- Benefits:
  - Helps households adjust consumption more smoothly.
- Risks and implementation caveats:
  - Invites free riding by borrowers not under severe financial distress.
  - Should be considered only for borrowers currently under proven financial strain with sufficiently strong prospects to recover debt service capacity.
  - Lenders must closely monitor forborne loans.
- Role in strategy:
  - Forbearance can act as a crisis stopgap that dovetails with later loan modifications during the recovery.

### Foreclosure will have to play a role
- Cross-country variation: foreclosure was widespread in some countries (particularly the US) and largely absent in others (such as Ireland).
- Trade-offs:
  - Benefits: strong foreclosure rights decrease lenders’ loan losses and contain opportunistic borrower behavior.
  - Costs: large scale foreclosures can depress house prices and trigger more defaults — especially harmful in systemic housing crises.
- Policy lessons:
  - Foreclosure moratoria introduced in some countries had mixed results; delays can increase opportunistic defaults and overall workout costs.
  - Making foreclosure more costly through temporary fees or taxes could incentivize lenders to consider foreclosure alternatives in a systemic crisis.

### Time to modify (loan modification)
- Definition: A loan modification is a one-time, permanent amendment to the terms of a loan which reduces the monthly debt service payments. The most common type is a maturity extension which reduces monthly amortization payments.
- Role in recovery:
  - Loan modifications can help homeowners overcome debt servicing difficulties as incomes and house prices rebound.
  - Determining the right modification at the height of a crisis is difficult; the recovery phase makes it easier to set suitable terms.
  - Loan modifications during the recovery phase complement temporary forbearance arrangements.
- Evidence and institutional support:
  - Available statistics suggest that more than 10 percent of mortgages underwent some type of modification or restructuring in each of the four countries.
  - Outcomes were often supported by dedicated policies, such as the Homeowner Affordable Modification Program (HAMP) in the US and supervisory workout targets in Ireland.
- Barriers and policy remedies:
  - High renegotiation costs and obstacles (prudential rules, taxes) limited the extent of loan modification.
  - Recommendations:
    - Strengthen policies to reduce barriers to modifications while applying tight eligibility criteria to contain free riding.
    - Frameworks for orderly debt renegotiation (e.g., a code of conduct or a statutory insolvency framework) can improve lender–borrower coordination.
    - Prudential or fiscal policies can set appropriate incentives to encourage loan modifications.

### Reducing distress through across-the-board debt relief
- Features:
  - Provides immediate relief to many mortgagees.
  - In Iceland, broad-based debt relief was facilitated in part by foreign bank creditors bearing the losses.
- Trade-offs:
  - High upfront cost of broad-based debt relief often outweighs economic benefits and would eventually need to be covered by taxpayers.

### Conclusion and policy recommendations
- No universal solution; policy must account for country-specific factors and the stage of recovery.
- Immediate aftermath of systemic housing crises:
  - Facilitate temporary forbearance as selective and time-bound breathing space for overindebted households.
- Recovery phase:
  - Foster durable resolution of distress by facilitating loan modification.
- Foreclosure:
  - Recognize foreclosure’s negative side effects in systemic crises, but retain foreclosure as an efficient resolution tool in some cases and as an incentive for constructive borrower behavior.

*Jochen Andritzky, March 11, 2015 — "Resolving Residential Mortgage Distress: Time to Modify"*

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## References

- [IMF Working Paper](http://www.imf.org/external/pubs/cat/longres.aspx?sk=42532.0)
- [housing recoveries](http://blogs.imf.org/2015/01/07/housing-bubbles-an-ounce-of-prevention-is-worth-a-pound-of-cure/)
- [https://www.imf.org/wp-content/uploads/2015/03/slide1.jpg](https://www.imf.org/wp-content/uploads/2015/03/slide1.jpg)
- [https://www.imf.org/wp-content/uploads/2015/03/slide2.jpg](https://www.imf.org/wp-content/uploads/2015/03/slide2.jpg)
- [https://www.imf.org/wp-content/uploads/2015/03/slide3.jpg](https://www.imf.org/wp-content/uploads/2015/03/slide3.jpg)

_Source: https://www.imf.org/en/blogs/articles/2015/03/11/resolving-residential-mortgage-distress-time-to-modify_