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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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The last three years have seen an amazing growth in the number of schemes designed to help homeowners keep their homes and help them avoid foreclosure. However, this is becoming increasingly difficult as the issue homeowners are having with their mortgages is not so much the interest rate and loan tenures, but with the fact they have lost their jobs, and cannot afford any kind of mortgage payments.

The fact that homeowners cannot afford their mortgages due to unemployment makes it very hard for governments to design the right loan modification or aid that will work for lenders and borrowers. The truth is that in many cases banks will profit more, or lose less, from foreclosures than loan modifications.

A new type of aid has been put forward to respond to the increasing percentage of prime loans that are heading towards foreclosure due to unemployment. These mortgages have little to be improved on; they generally have low interest rates and reasonable payment conditions. However, job loss has made it impossible for borrowers to continue making payments. The new solution is to provide temporary aid to the homeowner until he or she finds a job. This is an easier pill to swallow for lenders than making principal balance reductions or permanent loan modifications. It also sidesteps the long and slow road of loan modification trials.

However the question is what type of temporary aid should be provided. There are a variety of proposals. One is to simply pay the loans for unemployed homeowners that cannot afford their mortgage for a set number of months. This type of aid is already in place in various states.

Another option is to provide these borrowers with loans, the payment of which is deferred to a further date. This option does seem like giving people more rope with which to hang themselves, but it might be good is some circumstances. A third option some banks like Citibank have already started to use is to simply defer payments on a mortgage for a few months. The above mentioned bank has offered in some qualified cases 6 month deferment on mortgage payments to allow the borrower to get back on his or her feet.

This is a great option for the right borrowers because a) it does not cost the mortgage that much, b) does not have to go through such a strict and long selection process and c) actually deals with the problem of unemployed homeowners that do not qualify for loan modifications.

Needless to say many banks are wary of rescheduling payments that may never be made and putting off a foreclosure process that may already be inevitable. This is why the Government should look into the possibility of adding this measure to their flagship HAMP program and think of alternative measures that will deal with the increase in unemployment instead of just focusing on reducing interest rates. Many feel that the government is simply fighting the wrong war, (we are still talking about mortgages by the way) this measure might realign efforts in a direction that might be more productive. However a good selection process will be needed to assure that those that qualify really have the potential to find a job that will allow them to make realistic payments on their mortgage.

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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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There is a proposal for new guidelines in the way lenders and servicers deal with borrowers throughout the foreclosure process. These new guidelines are designed to improve communication between lenders and borrowers to improve the rate of troubled borrowers receive a loan modification for their mortgage.

One of the issues that leave many homeowners without a home is time and awareness. Troubled homeowners that are behind on their mortgage often do not realize the details of what will happen to their home and when.

This proposal suggests that lender and loan servicers, which are the companies that actually manage mortgage payments, should be required to provide homeowners with at least 30 days to reply when their loan modification has been denied under the HAMP program. These 30 days would give the borrower time to appeal, time during which the lender would not be allowed to continue with the foreclosure procedure.

The new guidelines would also put the responsibility on lenders and servicers to contact borrowers that are 60 days or more behind on their mortgage payments and fill the basic requirements for a HAMP loan modification. The guidelines are very specific in the nature of the notifications lenders must make before a foreclosure can proceed. There must be at least 4 telephone calls, two notices in writing, one of them which must be by certified mail. If these guidelines are approved it will mean a drastic increase in the work required for lenders to carry out a foreclosure. Extra staff will have to be brought in to fulfill these requirements.

However, these guidelines would also provide lenders with the right of denying a loan modification application that was filed within 6 days of a foreclosure sale. Loan Modifications can be lengthy processes and include a large investment in time and resources for lenders and servicers. Nevertheless, lenders will have to inform borrowers of the foreclosure schedule, and the deadline they must meet so that their application can be considered.

These are part of a list of requirements and guidelines the US Treasury is considering in their efforts of improving the rate of loan modification trial conversion and the number of troubled homeowners that apply for a loan modification. The idea is to screen those that actually qualify for the HAMP program and would benefit from the aid it provides.

Unfortunately the HAMP program is only designed to help troubled homeowners that still have a regular income and whose home has not dropped in value too drastically. For instance, if your mortgage is worth over 150% of your current home value, you might struggle to pass the NPV test required for a loan modification.

These proposals are working in line with others that are also being prepared for California and four other states that have suffered from a severe drop in house prices. The Obama Administration announced last week that these states will receive 1.5 billion dollar to be used at the discretion of each state to provide flexibility when considering borrowers for aid and loan modifications.

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It is hard to believe that three years have gone by since the housing market took a dive drowning with it millions of American homeowners. So what is the situation now? Have we hit rock bottom? Are the Administration’s measures starting to work?

Let us start with the good news. There are now over one million homeowners benefiting from temporary or final loan modifications. Admittedly, most of them are still in the trial period, but nevertheless, the Administration has made an effort to ‘encourage’ lenders and servicers to make an effort, sometimes by using a carrot and other times by brandishing a big stick. Another good newsbyte is that the rate of troubled homeowners, people behind on their payments, is dropping.

Also, new measures are being carried out as we speak. Just a few days ago Obama announced another program to avoid foreclosures. The program included offering $1.5 billion to housing agencies in California and four other states. These states have been especially hit by a fall in house prices making loan modifications harder to qualify for. This new program aims to provide these hard hit states with extra flexibility that will allow them to provide the help troubled homeowners need.

Unfortunately the good news is over. The bad news is that nearly 3 million homes are going through foreclosure and 4.5 million will do so this year according to conservative estimates. Another problem is that the figures we have may not even be telling the full story. Experts say that lenders have an estimate of 1.7 to 7 million homes in a shadow list of foreclosed home they are yet to put for sale. This fudges our foreclosure figures.

High foreclosure rates do not only affect the owners, it also lowers the price of homes in the neighborhood and cripples the economy as a whole. The question many are asking and we have discussed widely in this blog is how much should the government help. It is a fact that many borrowers overstretched their budgets to breaking point; these cannot and should not be bailed out. However, the fact remains that loan modification trial and completed number should be higher.

Another problem is the high re-default rates. These rates show some of the inadequacies of the current loan modification system. Studies show that re-defaulting rates are lower when the principal balance of the loan is trimmed or reduced. Unfortunately most loan modifications simply extend the term of the loan or reduce the interest rate.

What can the government do? Extra incentives for lenders and servicers might just make them weight for the next best deal, instead of focusing on providing fast loan modifications now. An idea that has been thrown around that seems promising is to give bankruptcy judges the power to write down mortgages like they can write down other kinds of debt. It is very likely that this would increase the interest rates of new loans to reflect the increased risk of loan balance reduction. However, it would provide a good incentive for lenders to negotiate reasonable loan modifications before a judge tells them to.

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If you do not qualify for a loan modification, and foreclosure seems unavoidable, there are steps you can take to make the most of a bad situation. One of these options is arranging with your lender for a Deed in Lieu of Foreclosure.

What does this mean?

It means you hand over the deed, or ownership, of your house to the lender in exchange of clearing your debt. The homeowner loses his home but is left without a debt while the lender takes immediate control of the house.

What advantages does this option have?

In certain circumstances a Deed in Lieu of Foreclosure can have significant advantages for both the lender and the buyer.

1)     The lender can take immediate control over the property. A much more efficient method than foreclosure proceedings that can take years to finish.

2)     The borrower foregoes his home but is left without any debt.

3)     Lenders can save themselves a lot of money in court expenses, time and other complications if they avoid a typical repossession procedure.

4)     Borrowers that avoid a foreclosure will remove the stain on their record and in some cases avoid bankruptcy.

What are the requirements for a Deed in Lieu of Foreclosure to be carried out?

1) The market value of the home must be less than the current balance of the mortgage.

2) There must be no third party credits secured by the home, like a second mortgage or a secured car loan.

Although it might seem counterintuitive for a homeowner to let his home, probably his largest investment, go without anything to show for it, it can be a much better alternative than a long and painful foreclosure. Borrowers don’t have to see their credit score hurt and can start again elsewhere, while lenders can cut their losses and try to make the most of a bad loan without having to continue spending money and resources.

In what circumstances should a homeowner think about handing a Deed in Lieu of Foreclosure?

Obviously, homeowners that are going through financial difficulties and cannot afford their monthly mortgage payments. However if they still have some sort of income then they may well qualify for a home modification or some other option. This path is more suited for homeowners that either cannot afford any kind of loan modification or feel that their home is too underwater, worth less than the mortgage balance, to be worth saving.

How is it done?

Both parties must agree to sign an Agreement in Lieu of Foreclosure. This document transfers ownership to the lender. In some cases the homeowner might pay a certain amount of money to reduce the loan and make sure her credit score is not affected. Once the document is signed the lender will issue a waiver to deficiency judgment, which will be used if the sale of the house is below the value of the mortgage. After this an escrow service executes the agreement; releasing both the lender and the borrower from their mortgage contract.

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Renting a home that is going through foreclosure? If so, don't be fooled: Lenders can't kick you out; they have to honor the terms of your lease.

Loan modifications are often presented to us as a murky, obscure and scary financial world of shadows where normal people like you and me should not even dare to tread without the faithful advice of an expert, or preferably two, for fear of being swallowed up by an ARM, or something worse, hiding behind the bushes. Fortunately, although there is some truth in the previous depiction, we can understand the mechanics behind loan modifications and work with along with a trusted expert without playing the part of the helpless victim.

Lenders, like most predators, are simple creatures; they just use complicated jargon and scary formulas as a smoke screen. Lenders are only interested in two things: your hardship and your income, which when you really think about it, is the same thing.

This is one of the dirty secrets of loan modifications, unfortunately there are many, but this is a big one. Lenders are only interested in what you can afford to pay. If you can’t afford to pay any reasonably priced mortgage they are not interested in you as a client and will foreclose or short sale your home before you can say Jack Robinson.

Therefore, it doesn’t take a rocket scientist to realize that it is of vital importance to present yourself to your lender in the right financial light to stand a chance of success. This is tricky. You need to be able to prove there is no way you can afford the current mortgage payments while establishing without a shadow of a doubt that you are a perfect candidate to a modified loan with lower monthly payments. Get that right, and you have just increased your chances of success beyond recognition.

How do you get it right?

The key is to understand your enemy – I mean your lender. You must see through his eyes and understand how a lender calculates your income. The way lenders calculate your income when assessing your loan modification application is different to the methods used for traditional home loans. Surprisingly, this is good of thing, because guidelines are set in your favor.

The first step is to write a hardship letter deserving of a Pulitzer Prize, more on that later. Second, you must prove you do have the income to pay for your modified loan. The first step disqualifies you from your present loan, while the second is designed to qualify you for your new one.

When you calculate your income for a loan modification you can use any income, that you can prove, of course. And I mean any, it doesn’t even have to be completely legal, as long as you can prove it. For instance you can include income from a second job you get paid for… let’s call it informally, without a problem. You can include your grandparent’s SSI, or your spouse’s income, even if they aren’t on the mortgage, just as long as you can prove it.

Proof must be provided in the form of bank statements, 1099 forms or in some other documentable form. The specific guidelines change and will be detailed in your submission paperwork. All this evidence of your income is the backbone of your loan modification application, get it right!  You will need it to write an effective hardship letter and to pass the NPV test, both of which you need to do to qualify for a loan modification.

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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 23^rd 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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