Troubled homeowners are so worried about losing their home they will do anything to save it. This generally ends up including a loan modification. Loan modifications are a way of reducing monthly payments by a) reducing interest rates, b) extending the tenure of the loan, and c) in some rare cases even by reducing the principal balance of a mortgage.
However, many home owners are starting to realize that interest rates and mortgage payments are not the only things that are being lowered. The credit score of homeowners is being reduced by up to 100 points just for entering a loan modification program. 100 points in a scale that generally goes from 300 to 850 points is a significant blow to a homeowner that has taken good care to protect his credit rating.
The big question is: is it fair? Should it be done?
The main argument housing counselors are putting forward against this practice is the lack of transparency. Most of the times troubled homeowners that ask for a loan modification feel like they are doing the right thing by trying their best to pay for their mortgage despite financial problems. When they realize that there credit score has been hit despite their efforts the sometimes feel cheated.
Are they justified? It seems reasonable to me that lenders and mortgage servicers provide clear information on the consequences of taking on a loan modification. But would a troubled homeowner applying for a loan mod change his mind just because he realizes his credit will be affected? If they do, it probably means they did not really need it to start with.
Why should a loan modification affect your credit rating?
Credit scores and rating are in place to do one thing, help banks and lenders know how reliable a borrower you are. Reliability in this industry is proven by your credit history that is how good you have been at paying your debts, your income and your commitment to the security of the loan, in this case your home.
A credit score is a numeric value assigned to you that qualifies your credit history and how desirable you are as a lender. Now, let us try and detach the emotional aspect of being a troubled homeowner and think about the consequences of a loan modification. A loan modification will in the vast majority of cases mean a reduction in interest, principal balance, or both. This means the bank is losing money. Losing money the borrower agreed to pay. By applying for a loan modification the borrower is stating he or she is struggling to make the payments they agreed to make. Shouldn’t that affect their credit rating, their reliability as a borrower?
Even though applying for a modification will take a chunk from your credit rating it is probably going to shade into insignificance compared to the effect falling behind in your mortgage payments and God forbid, foreclosing on your home. These actions can leave your credit score in tatters for years, and fade into insignificance when compared with a 100 point hit.
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This Thursday the Obama Loan Modification Plan, HAMP, will be a year old. It was on the 4th of March, 2009 that the Obama administration started the largest and most ambitious homeowner’s aid package since the 1930s. The goal was to stop the wave of foreclosures that was destroying the housing market. The Government’s reply was huge. The aim was to help four million homeowners avoid foreclosure and they were willing to spend $75 billion to do so. How are things looking as we approach HAMP’s first birthday. By December 2009 there were nearly 760,000 loans in the trial stage of the program. This three month trial stage is designed to test if the homeowner will pay his modified loan for three months before the modification is final. However, only 31,000 homeowners had actually received a permanent loan modification by the end of 2009. Of these many had seen only the slightest of changes to their monthly payments. The Obama administration realized they needed to do more, and quickly. This triggered a list of amendments and countermeasures designed to speed up the process and open the doors to more homeowners. Soon it became obvious that the issue was not the interest rates of bad loans that were hurting homeowners but the increasing rates of unemployment that was reducing the income of homeowners that could not afford to pay for their mortgage. In fact, the fastest growing demographic in the foreclosure market consisted of homeowners with prime loans that had lost their jobs. From the beginning of the program, the Treasury Department made it very clear that the program would not cater for families that no longer had an income because of losing their job. The aid was focused on families whose income had shrunk but could still afford the payments of a modified loan. Another issue was the complexity of the loan modification process. Homeowners complained that mortgage servicers were not consistent, lost important documents regularly and did not provide accurate information. Mortgage servicers on the other hand explained that homeowners often did not provide the right documentation and were less than honest when filling forms. Treasury reacted by simplifying the system and providing greater concessions to lenders and mortgage servicers. Industry leaders often made the valid point that the HAMP plan incentives did not cover the costs and it was better for them to continue charging fees from delinquent homeowners and foreclosure proceedings than approve loan modifications. The reaction was to increase the incentives and the arm twisting of lenders that would not comply with the program’s expectations. The incentives did become rather generous for both servicers and borrowers. Every loan a servicer modified came with a $1,000 upfront payment, with an extra thousand dollars every year the homeowners was current on payments. This means the Treasury will pay $1,000 every year the borrower is not delinquent, to reduce the loan balance. However the biggest subsidy was offered to reduce the actual monthly payments of mortgages. If the lender could reduce the monthly payments to 38% of the borrower’s income the government would pay for the cost of reducing the payments to 31% of the family’s income. The problem is that these measures have not been sufficient to stem the increase in foreclosures and new guidelines are being worked on to look for a solution. Unfortunately the prospects do not look good for the second year of the Obama Loan Modification Plan.
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Recent projections estimate that by June, over 5 million homeowners will be heavily underwater. Let us define that a little more precisely. You are heavily underwater if the current market value of your home is only 75% of the balance on your mortgage. Between you and me, this means you are pretty screwed. The scary part is that if this projection proves true 10% of all US homeowners will be in this pickle; not the place you want an economy to be if you are trying to dig yourself out of a recession.
This is why the Obama Administration is running about like headless chickens trying to find solutions to this problem, quick, mid-term, and long term solutions; any kind of solution that will get us out of this.
It was this kind of panic that caused the government to put all their weight behind HAMP, the government’s loan modification program. Loan modifications were and always have been procedures designed to help homeowners stuck with sub-premium loans. Sub-premium loans as you all know is a kind way of talking of usury, loans with interest rates so high they give you vertigo if just to think about them. However loan modifications are not, and never have been a fix for homeowners with great loans that are unemployed and cannot afford their mortgage.
What alternative solutions are there?
One proposal is to buy time by simply banning foreclosures until other options have been looked into by the homeowner and lender. You have to love that proposal, if you cannot stop homes foreclosing by economics just make it illegal. As crazy as this measure seems it is designed to buy time and allow homeowners to find ways of keeping their home. This would take the current guideline of asking lenders to evaluate defaulting homeowners for a loan modification to the next level by making it compulsory.
The Mortgage Bankers Association says its members are already following this principle, and that foreclosure is always a last resort when all other options have been exhausted.
Another plan sponsored by the Mortgage Bankers Association is to not modify permanently the loans of troubled homeowners that have lost their jobs but simply to reduce their mortgage payments substantially for up to nine months to give homeowners a chance of looking for a new job.
As you probably guessed the Banker’s Association is requesting Treasury to pay for the program. Nevertheless, it does seem like a good idea to provide a homeowners with a break until he finds a new job than taking forever to marginally reduce the mortgage payments of an unemployed borrower.
However, many are analysts are saying that the real strategy to follow is to find a way to improve the economy. A strong job market would pull out the housing market from the fix it is in. On this theme, there were some good news last week. The number of homeowners starting to default unexpectedly dropped in the fourth quarter of 2009. However, the government also reported that home prices dropped by 1.6% in December; making it clear that the economy still has a long way to go before it gets a clean bill of health.
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Forensic Loan Auditing is a fancy way of describing a thorough revision of the documents you signed when applying for your loan. This includes the accuracy of the math in the interest rates and payments schedule, the legality of the terms of the loan and any proof that you were misled in some way.
Why is Forensic Loan Auditing useful?
Forensic Loan Auditing is useful because if your mortgage did not comply with the Federal Guidelines for lenders at the time of signing there is a chance your mortgage was illegal, or at the very least non-complying. This can cause your mortgage to be void and your loan to be wiped out. Admittedly this does not happen all that often, but you can see why servicers and lenders take a Forensic Loan Audit very seriously.
If you took out your mortgage a few years ago, before the current financial crisis, it is likely your loan fails Federal Guidelines on some level. In boom years, like those we had three or four years ago, banks and servicers are very relaxed with their interpretation of Government guidelines. This is especially the case with laws relating to RESPA, TILA or the infamous section 32.
How To Carry Out A Forensic Loan Audit?
There are two ways, the easy but expensive option and the difficult but cheap route. It all, of course, depends if you do it yourself or employ a professional.
Because of the number of loans in trouble forensic loan auditing is becoming a booming industry. However, don’t be quick to believe those that say you can’t d it on your own?
This is what you will need to do:
1) Check the date you signed your loan documents.
2) Check the Federal Loan Guidelines for that period.
3) Compare them with the terms you accepted and the documentation you signed.
The responsibility for any illegal procedures falls on the lender and/or servicer that are required to follow current law, so if you find any discrepancies it could provide you with extra leverage against your bank when asking for a loan modification or even make the loan void if serious mistakes were made.
Lawyers will of course happily do all the work for you, and are likely to do a much better job. However they don’t come cheap. Some loan modification companies include forensic loan auditing as part of their service. Nevertheless make sure you check the costs of using a loan modification company because the Government has provided free counseling companies that are just as good if not better than any paid service provider.
Forensic Loan Auditing is not the Holy Grail of Homeowners but can be a useful tool for certain loans in providing leverage against unhelpful banks and in rare cases even cancel the debt on your mortgage.
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Loan Modifications do seem to have finally got moving. Trial loan modifications are heading towards their first million, there has been over a 100,000 completed loan modifications and even Bank of America, the sleeping giant of loan modifications has hit the 200,000 trial modifications line.
However, what is not clear is if loan modifications are actually a good thing for homeowners. Reports published in this website have shown that loan modifications may be pushing homeowners deeper underwater instead of lending them a helping hand, pun intended.
This is because many banks are simply cashing in the Government’s incentives while capitalizing the late payments and interest charges onto the loan modification without reducing interest rates or extending the loan term, reducing the principal balance of the loan is, of course, very rarely even mentioned.
So is it worth going for a loan modification? It depends on:
1) How good a deal you can get on your loan modification.
2) How underwater your home is and
3) How much you care about your home
Let’s analyze these three questions to see if loan modifications are worth it in your particular scenario.
1) You are getting a good deal on your loan modification if the lender reduces your interest rates and your monthly payments are significantly cheaper. Unfortunately, in the recent past banks have got away with providing loan modifications that simply put borrowers further into debt. However, Government guidelines effective from the 23rd of November 2009 clearly state that loan modifications under the HAMP program, which provides incentives to lenders, must reduce the interest rate to the current market rate.
This is the pertinent paragraph in the Mortgagee letter 2009-35 from the Government to all approved mortgage providers:
The Mortgagee shall reduce the loan modification note rate to the current Market Rate. For purposes of this requirement, the Department shall consider Market Rate to be no more than 50 basis points greater than the most recent Freddie Mac Weekly Primary Mortgage Market Survey Rate for 30-year fixed-rate conforming mortgages (US average), rounded to the nearest one-eighth of one percent (0.125%), as of the date the Modification Agreement is executed.
What does this mean in practice?
The next paragraph in Mortgage letter 2009-35 gives the answer with an example (italics and underlining are ours):
The Mortgagee approves a Loan Modification that is executed by the borrower 35 days after the date of this Mortgagee Letter. The current note rate is 7 percent and the most recent Freddie Mac Weekly Primary Mortgage Market Survey Rate for 30-year fixed rate conforming mortgages (US average) as of the Modification date is 5.04 percent. To be eligible for payment of a mortgagee incentive and costs for a title search and/or recording fees on the Loan Modification, the fixed note rate on the modified loan may not exceed 5.50 percent (The Freddie Mac US average rate of 5.04 percent rounded to the nearest eight of a percent plus 50 basis points).
If your mortgage provider reduces your interest rate by nearly 1.5% you are likely and extends the mortgage for 30 years you are likely to see a very significant reduction in your monthly payments. However, don’t forget to check what the term extension will translate to in extra interest and make sure you can live with it.
2) If your mortgage is so underwater there are little chances it will ever be worth what you bought it for and you just started paying for it, you need to decide if it is even worth trying to save it. Walking away, taking the hit on your credit and starting fresh might be the best option for you.
3) Of course this depends how much you have emotionally invested in your home. If you can’t find another home in the area and you don’t want to change your children’s school, or you need to live near your parents the financial value of your home might only be one of the factors you have to consider.
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Loan Modifications and Home Refinancing are been talked about so much they are becoming the most used financial buzzwords by homeowners nationwide. This doesn’t mean people understand the differences or the financial consequences of either of them.
This article seeks to look into the pros and cons of Loan Modification and Mortgage Refinancing and to provide clear guidance to when it is best to modify your existing mortgage or to refinance it altogether.
Let’s start with some basic definitions for Loan Modification and Mortgage Refinancing so we are on the same page on what we mean by these terms.
Loan Modifications.
Loan modifications are used as a tool to lower the monthly payments of troubled homeowners. The whole purpose is to help people that are struggling to pay their mortgage by either lowering their interest rates, extending the term of the loan or in some cases reduce the principal balance of the loan.
You do not need to have equity on your home to apply for a loan modification, the government is actually subsidizing loan modifications through the HAMP program so that more homeowners can qualify.
Mortgage Refinancing.
Mortgage refinancing is a way for borrowers to get a better deal on their mortgage. You effectively pay off the current mortgage and negotiate a new mortgage with better conditions. This can mean lower monthly payments, lower interest rates, a shorter loan term, which reduces the cost of the loan, or a safer interest rate type (fixed, variable, ARM)
You can refinance with your existing lender or with a new lender. You do not need to be in financial difficulties to apply for a mortgage refinance. You will generally need to have some equity on your home for a lender to agree to refinance your home and be able to afford the new monthly payments which will not be necessarily be lower.
Which is the best for you?
This is a question only you can answer, because it completely depends on your personal circumstances. Here is how you work out which is the best option for you:
1) Do you have equity on your home?
Or put another way is the current value of your home lower or higher than the pending balance of your mortgage.
If you have negative equity, or owe more than the house is worth, then you are really going to struggle to refinance your home unless you are willing to pay ridiculously high interest rates, extend the term of your loan or/and increase the cost of your monthly payments. You don’t have to be a finance guru to know that is not what you want. If you are in negative equity nine times out of ten you are better of getting a loan modification, which in its current form was pretty much designed to help out borrowers in your situation.
However if you are fortunate enough to have a decent equity on your home you are very likely to find a lender that is willing to refinance your mortgage with a better deal; especially if you bought your mortgage a few years ago when interest rates were higher.
2) Are you worried about your credit score?
Loan modifications affect your credit score whatever your lender has told you. Refinancing your mortgage does not affect your credit score negatively, it might even improve it. It is true the government has created a new “label” for people that apply for loan modifications which in theory will not affect your credit score but the truth is that it will; if not right now it will in the near future. Banks and lenders are wary, quite understandably, of customers that ask for breaks on a loan agreement, and that is what you are doing when you ask for a loan modification.
Nevertheless if you are struggling to make it to the end of the month and have little or no equity your goal is to save your home and your credit rating is probably the least of your worries. Get a loan modification.
3) Does it reduce your interest rates?
This is the big question. Whichever road you take, Loan Modification or Mortgage Refinance you need to make sure your interest rates have dropped or you principal loan balance has been reduced, the latter is very unlikely I’m afraid. If your interest rates are not lower any savings on your monthly payments are going to cost you in the long run, look for a better alternative.
To illustrate, refinancing your mortgage could cost you anything from 0% to 3% of the balance of your mortgage but if you negotiate a lower interest rate, preferably a lower fixed interest rate, then you could recoup your costs in three to six months. If your interest rates have not dropped you are just giving your money away to the bank.
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Do loan modifications affect your credit score? Should they? Why should you care?
Credit scores are a numerical value credit bureaus place on a borrower as a way of measuring their reliability. It is in the interest of lenders to report any delinquent activity to the credit bureau. In fact some would argue that it is in the interest of everyone as delinquent borrowers make loans more expensive for everyone by forcing lenders to increase interest rates to pay for bad loans. This is why potential borrowers that have bad or low credit scores find it harder to get loans approved or have to pay a premium for the privilege.
Borrowers that don’t make one or various payments are marked by a special code that informs other lenders of the situation. Borrowers that are granted a reduction of their loan balance or monthly payments due to financial difficulties are also marked with a special code called AC. This code can reduce the credit score of a borrower by anything between 30 and 100 points and tells lenders that the borrower had only made a partial payment.
The problem arose when troubled borrowers entered the loan modifications sponsored by the government and were granted loan modifications without ever having missed a payment but were still marked with AC as it was the closest fit in the “system”.
The Obama Administration felt it was unfair to harm the credit scores of borrowers that sought a loan modification. Therefore a new code “CN” was thought up which will not have an impact on credit scores for now.
The question is if this will change. Will the code CN affect the credit score of borrowers in the future? This is still to be determined. It will depend on if FICO, the company behind the most popular credit score formulas, decides the appearance of CN in a credit report increases the chances or is predictive of delinquent behavior.
It is worth noting that borrowers that enter into a loan modification are asking for a reduction of their loan and are therefore not wonderful news for lenders that are looking for reliable customers. It is not at all clear to me why it is wrong that their credit score is somewhat affected.
However what is certain, and this is what worries the Administration is that borrowers with a good credit history will shy away from a loan modification that threatens their credit. Lenders might argue that borrowers who feel they have a choice and prefer not to enter into a loan modification that would damage their credit don’t really need it and can very well pay the full loan, thank you very much.
How you feel about the matter may very well depend on which side of the fence you are looking from. The Obama Administration wants to give HAMP the best chance possible and is eager to erase any bad publicity the program attracts even if this means fudging credit reporting codes. Whether these measures are long lasting or not will depend on the performance of borrowers that enter into a loan modification, it must be said at this stage that things don’t look all that good.
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This is the question administration consultants and officials are asking themselves. After using every trick in the book and more to “encourage”, “bribe” and “bully” servicers in providing loan modifications, loan modification conversion rates are still terribly low.
Ineligible Applicants.
Some have reasoned that the reason loan modification conversion rates are so slow is that many borrowers are simply ineligible under the current loan modification program, also called Home Affordable Modification Program (HAMP). HAMP does condition acceptance into the program, homeowners must be able to afford the modified payments, the cost of housing must not exceed 31% of the households income and the NPV test (Net Present Value) must be passed among other requirements before a loan modification is granted permanently.
Wrong Crisis.
A parallel argument is that the HAMP program is simply targeting the wrong problem. The issue, in the opinion of those that voice this argument, not a mortgage crisis, but a credit or unemployment crisis. It must be granted that with many homeowners their mortgage is the least of their worries or at least only one of many.
This argument seems to be validated by the fact that more and more troubled homeowners have prime loans with excellent interest rates and conditions but are struggling with their mortgages because they are unemployed. Modifying the mortgage payments will not help these homeowners which in most cases aren’t eligible for a modification anyway.
Greedy Servicers.
Some have pointed out that in many cases loan modifications simply don’t make sense for servicers because they cost more than they are worth, at least for servicers. Servicers, often banks, manage mortgages for lenders. They don’t supply the cash but deal with customer service, collect payments and pass them on to the lender or lenders of the mortgage.
Loan Modifications are too expensive.
A similar line of reasoning points to high cost of modifying a loan. Lowering the interest of a loan or reducing the principal can cost lenders tens of thousands of dollars with the added risk that borrowers can re-default despite the money invested in the loan modification. From a business standpoint if can seem logical for banks to say no thanks to government incentives which are often inadequate and cash in on a foreclosure.
If any of these explanations are true of if they all contribute to the program is hard to say. What does seem clear is that we are dealing with a complex crisis that will not be defeated with any one silver bullet. A combination of economic and social measures will be required to fight the housing, credit and unemployment crisis the U.S and world as a whole faces.
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