Ok, so just about everybody has heard about loan modifications, or loan mods for short. They are also called loan workouts, loan restructuring, among others. I’m going to explain what types of loan mods exist, and who can or can’t likely get them.
What kind of loan modifications are there?
There are a few different flavors.
Tack it on the back A common one is for people who are behind in their mortgage payments right now, to take the past due and put it on the end of the loan. Let’s say somebody has a $200,000 mortgage, and is behind three payments at $1500 each. If there was a temporary reason the homeowner got behind, like a job loss, and now they are making income again, the bank can put the past due at the end of the loan and give the homeowner a fresh start.
Recasting If somebody had an adjustable rate mortgage (ARM) that went up after 2, 3, or 5 years, and the payment jumped up, the lender can “re-cast” the ARM for a longer period to keep the payment the same. Let’s say somebody had 5.5% on an ARM, and on the adjustment date it went up to 7.5%. Depending on the loan size, the difference can be hundreds of dollars monthly. This can obviously cause some hardship for the homeowner, especially if they are making less now than before, like much of the country is experiencing. What the bank might do in this case is either “fix” the rate for another 2 or 3 years so the payment stays the same, or just convert it into a fixed rate at the same rate. These types of modifications are almost always contingent on the homeowner having good payment history prior to the adjustment.
Debt forgiveness A third type is debt forgiveness or principal reduction. This is common in short sale scenarios. Let’s say somebody owned a house that was once valued at $300,000. They had 90% LTV financing for a loan amount of $270,000. And now they have to sell the house because of job relocation or because their income level has changed and they need to downsize. But the problem is that the house that was once worth $300,000 can now sell for only $240,000 (a 20% drop from peak value is not uncommon these days). The bank knows that if they have to foreclose on the house, it would sell at auction for much less than the $240,000, so they agree to accept a smaller payoff because it is a smaller loss. Short sales are also common for somebody facing foreclosure for the same reason-the bank is taking the lesser of two evils. If a $300,000 house goes into auction, it may sell for $170,000 or $200,000, but if the homeowner sells it, it will go for much higher, and the bank will save thousands in principal and legal fees.
Payment or rate reduction One last type is payment reduction or rate reduction. Again, if somebody is struggling, but the lender believes they could stay current with a lower rate or smaller payment, they might agree to it because it is the lesser of two evils. They are making less on the loan, but it beats foreclosure. If somebody is making less income now, the bank may agree to lower the payments to help the homeowner stay current. Another way to lower the payment is to stretch out the note for 40 or 50 years. Many banks will do this in lieu of lowering the interest rate because then they can lower the payments to help the homeowner and still make the same interest. In a settlement with the State of Illinois, mortgage giant Countrywide had to re-cast all of its stated loans that their retail branches originated to do the new payments on full documentation, and give homeowners payments they could actually afford. There were people who got 2 or 3% over 40 or 50 years because of this.
But why can’t I get a loan modification?
So here is the hard pill to swallow: most borrowers who have been perfect on their pay history cannot get any help. “But I pay my mortgage on time, why won’t they help me? That doesn’t make any sense!” Oh, if I only had a nickel…
Banks, lenders, and investors (who buy mortgage paper) do it to make money. It’s a business. They don’t care about you, or your home, or your kids’ college fund. They care about the bottom line. I’m not bashing them; that’s why any business exists, be it insurance, car dealers, or any of the hundreds of retailers at the Woodfield Mall: to make money. UNICEF doesn’t do mortgages. Once you understand this, you’ll understand why you may or may not be able to get a loan mod. If the bank doesn’t see you as a risk for default, they won’t do a loan mod, plain and simple. If you make timely payments, and have been doing so, and are still living in the house, your odds of getting a loan modification are slim and none. (And slim just walked out the door.) Because, “I want a lower payment, and because I don’t want to be upside-down on my house,” are not compelling reasons for a lender to do a loan mod. I’m sorry to say it, but that is the harsh reality.
And loan mods will likely not be offered to somebody who has a lot of equity. If you owe $100,000 on a house that is worth $250,000, and you are having trouble with the payments or facing foreclosure, you are also unlikely to receive help. Why? Because if that house goes into foreclosure, the bank will get all of its money and then some. If that house goes to auction, it might fetch $135,000 or $150,000, more than enough to cover accrued interest and legal fees. Lenders and investors will take the route that is the most profitable or causes the least loss. Again, it’s a business, and they make business decisions. The president wants to stop foreclosures, the lenders just want to stop their losses.
Loan modifications often depend on your lender
And it matters matters a lot who has your loan. If yours was a Fannie Mae or Freddie Mac “conforming” loan, you are more likely to get a loan modification. This is because Fannie and Freddie are government-controlled; they are better able to absorb losses, and they are under pressure to help stem foreclosures. And if you have a HUD-backed FHA loan, your odds are even better. FHA rules state that a lender MUST try to work something out before foreclosure. Since the loan is insured by HUD, they can call the shots. Now, a FHA lender may not offer a modification up front, but if the borrower asks for it, they are obligated by law to try to come to some resolution before foreclosing. This certainly slants in favor of the homeowner, but most people aren’t aware of this, and just throw their hands up in defeat. And certain lenders, including Countrywide and Chase, have made headlines for their efforts to try to stem foreclosures.
What if your loan isn’t a Fannie Mae, Freddie Mac, or FHA loan? Well, unfortunately, your odds are much worse. If you have a “sub-prime,” “portfolio,” or “alt-A” loan, you will likely only get a modification if you fit one of the above described scenarios. Lenders and investors have taken huge losses on these types of loans, and if they aren’t at risk of taking further losses, it is unlikely you will be able to accomplish any kind of loan modification whatsoever.
Don’t kill the messenger, I’m just telling you like it is.
It looks bad for me getting a loan modification, but I want to try. What do I do?
This part won’t make me any friends. I’m sure you have probably heard of loan modification companies. Many of them are very good at what they do. But, they aren’t doing anything for you that you likely couldn’t get done yourself. As a loan officer, I get approached by loan modification companies all the time, but I can’t, in good conscience, charge somebody (who is already in financial trouble and doesn’t have much to spare) for something they can do themselves. Now, I want to forewarn you, it will be an uphill battle regardless of your situation. If you think it is worth it for somebody else to fight for you so you don’t have to worry about it, then a loan modification expert may be for you. When you call, you don’t want to talk to the customer service schmuck. He can’t do anything for you. You want to get to the loss mitigation department. It’s an entirely separate department from the general customer service. They should be able to give you a phone number and an address for them. Loss mitigation is the department that tries to minimize losses, and that’s who you want. The best advice I can tell you is to be the “squeaky wheel.” Call them and write them. And call again and write again. You may spend an awful lot of time on hold. You may wait days or weeks to have a call returned. It absolutely will not be easy. But, if you are talking to right department, and are persistent-call, write, fax, send smoke signals if you think it will help and you fall into one of the groups that should quality for a loan mod, you should eventually get it done.
Thoughts on loan modification companies? DON’T pay up front
I have a few final thoughts on loan modification companies. This is for the most part uncharted territory, and the rules and regulations around them are murky at best. Sometimes the law has to catch up with modern day reality. First and foremost, DON’T pay huge fees up front. I have read a press release from the Illinois Attorney General’s office saying that it was illegal for loan modification companies to charge anything up front, and that they can only get paid once the mission is accomplished. I don’t know where the legal battles have ended up, but it seems fair to only charge people that you accomplish something for, or to keep the up front fees modest. I have heard of companies that charge a smaller fee up front, like $300, and a larger one once it is worked out. I have heard of companies charging $3500 or more for their services. The going rate seems to be around one mortgage payment, or maybe one and a half. Like almost all things in life, these fees are negotiable. The people who do loan mods are making commission, I promise you. Not that commission is a bad thing; loan officers and real estate agents typically get paid commission also, but you should know up front what you are dealing with. I heard one story where a homeowner was asked to pay a few thousand up front, but it would be refunded if they couldn’t complete the loan modification for him. What?! Why would you take anything at all up front then? That makes no sense to me.
Bottom line is: do your homework. Just like if you were going to buy a car or get a mortgage, you would do some digging, ask some questions, get some advice, and maybe shop around some. If you are going to hire a loan modification guy, do the same thing.
I wish the very best to anybody reading this in these trying times.
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