Since the mortgage crisis took flight, “loan modification programs” have become all the rage. Instead of originating new loans, former mortgage brokers and loan officers are shifting focus to reworking outstanding loans that have fallen behind in payments or are in danger of doing so. Ironically, many are getting paid to reverse the damage they caused to begin with.
In the past couple years, millions of borrowers have fallen behind on their monthly mortgage payments, creating an unprecedented foreclosure epidemic. And because home prices are falling, many are seeing their home equity sucked dry or even worse, finding themselves underwater on their mortgages.
This environment has forced banks and mortgage lenders to begin modifying loans in an effort to recoup losses and prevent foreclosures, which puts even more downward pressure on home prices. Things have become so dire that a number of banks have initiated their own streamlined loan modification programs to complement their standard loss mitigation efforts.
There are also foreclosure prevention coalitions, such as Hope Now, which provide free assistance to struggling homeowners through a streamlined process using existing loss mitigation tools.
So now that we have a little background, let’s take a look at some of the most common loan modification options available to at-risk borrowers.
A repayment plan is one the most simple and typically most common loan workout options available to borrowers in arrears (behind on payments). It’s not really considered a loan modification, because the terms of the loan are essentially unchanged. Basically, the bank or lender will agree to take your delinquent payments and add them to your current monthly payments until you become current again. So if you owe say $4,000 in arrearage, they may add $500 to your monthly payment for eight months until you’re back on track.
Critics have panned repayment plans because they fail to address the affordability issues tied to delinquent loans. Because the debt is simply redistributed, borrowers who can’t afford the terms of their loan will likely re-default within months of receiving a repayment plan, especially as the monthly payment increases as a result.
A better option might be the Home Affordable Modification Program (HAMP), a government loan modification program that lowers payments based on what homeowners can afford to pay.
Interest Rate Reduction
A more favorable loan modification is one that involves an interest rate reduction, so the monthly payment is actually made more affordable. In this case, the loan will be re-underwritten to determine what size of payment you would qualify for at a given debt-to-income ratio, generally around 38 percent.
The mortgage rate may be temporarily lowered, for a period of say five years, and then steadily increase, to the market rate at the time of modification, or it could be fixed for life. This is clearly a favorable option, as it cuts the borrower’s monthly payments for good.
A common example of this is HARP, the government program that allows borrowers to refinance to a lower rate even though they lack the necessary equity typically required to do.
Another relatively easy ways for banks and lenders to increase affordability and reduce monthly mortgage payments is to extend the amortization of the loan. Instead of a standard 30-year amortization period, the loan may be stretched another 10 years, pushing payments to a more acceptable level for the borrower.
While banks and lenders aren’t generally keen to offer principal reductions, it’s becoming increasingly common as desperation grows. Since so many borrowers are underwater, banks have little choice but to reduce the balance of the existing mortgage to put the borrower in a positive equity position. However, there are strings attached. In exchange for a principal reduction, some banks want a piece of the future appreciation, assuming there is any. This has created a huge hurdle, as no one can agree on what’s fair.
This method, which is only available for FHA loans, creates an interest-free second mortgage that contains up to 12 months of accrued mortgage payments. It brings your account up to date immediately, and must be paid off when the first mortgage is paid off or the property sold.
Fannie Mae HomeSaver Advance
HomeSaver Advance is an unsecured personal loan, used to cure delinquency on the first mortgage. It’s a 15-year fixed-rate loan at five percent with no interest accrual or payments for the initial six months. The loan amount can be as much as $15,000, or 15 percent of the unpaid principal balance. Proceeds are applied to delinquent payments, interest, taxes, insurance, escrow advances or foreclosure/bankruptcy-related fees. No cash received in-hand.
Keep in mind that banks, lenders, and housing counseling agencies may use any combination of the above approaches to get monthly mortgage payments to acceptable levels. For instance, it may take both extended amortization and a reduced interest rate to qualify a distressed borrower, or even principal reductions.
Also understand that some borrowers may be beyond help, as some loans underwritten over the past few years were riddled with fraud and should have never been extended to the borrowers to begin with, so foreclosure is inevitable for many. Keep your eyes and ears open, as new loan modification programs are popping up all the time. Make sure you contact your loan servicer or lender immediately if you need assistance.
One final note…watch out for loan modification scams, which seem to be growing in prevalence as the situation worsens. Many so-called assistance programs simply create a middleman who will charge you more fees and possibly put in you a more dire position.