Most modifications today reduce monthly payments by lowering the interest rate, extending the loan term, and offering forbearance, where payments aren’t required on a portion of the loan balance. So far, Mr. DeMarco says the performance of modified mortgages depends most heavily on how much a borrower’s monthly payment has been reduced—not the extent to which a borrower is upside-down on the mortgage.
“We’re just not seeing the borrowers’ willingness to pay vary by their loan-to-value,” said Mr. DeMarco.
But advocates of write-downs say banks can design programs that help limit their appeal to only the most desperate homeowners. “You need to introduce frictions to achieving principal write-down so that those who really need it, get it, and those who don’t really need it will see that the other guy is getting not a windfall,” says Laurie Goodman, senior managing director at Amherst Securities Group LP.