Loan Modification -- A Clarification
The term "loan modification," virtually unheard of before the foreclosure crisis, has elbowed its way into conversations all over America. Millions of homeowners are being inundated with postcards, emails and phone calls offering loan modification services. Millions more are going the DIY route, attempting to negotiate a “loan mod” for themselves directly with their lender. The reality is, most homeowners are not even clear on exactly what loan modification is! This confusion, combined with financial anxiety and fears of foreclosure can cause panic, paralysis and poor decision-making. In order to make smart decisions when it comes to modifying your mortgage, you must first understand what loan modification is, how the process works, and what outcomes you can expect.
Demystifying Loan Modification
In short, a loan modification is an agreement between a lender and a borrower to change one or more terms of the mortgage. The most commonly modified mortgage terms include:
- the length of the loan (e.g., extending a 30-year mortgage to a 40-year mortgage);
- the interest rate (e.g., reducing a 7 percent rate to 6 percent);
- the variability of the rate and payment (e.g., converting an adjustable rate mortgage [ARM] to a fixed-rate mortgage); and
- late payments (e.g., reinstating a past due loan and deferring missed payments to the end of the loan).
The loan modification process varies from lender to lender, but generally involves several steps:
- The borrower contacts the lender’s loss mitigation department to initiate the application process.
- The borrower provides the lender with income, expense and asset information and documentation.
- The borrower submits a hardship letter detailing why the borrower is facing mortgage and financial distress, and why they will be able to get and stay current on the mortgage, if modified.
- The lender considers all of this information and makes a decision about whether to modify the mortgage, and which terms to modify.
Controlling Great Expectations: What To Expect From Loan Modification
We have all heard that mortgage banks do not want to foreclose on homes, which has created the expectation that loan modification requests will be viewed favorably by lenders as a homeowner’s good faith effort to avoid foreclosure. The reality is a lot more complicated than simply asking for and receiving easier mortgage terms.
In the current market climate, most struggling homeowners are looking for two things: a lower monthly payment and the holy grail of loan modification -- principal reduction. Principal reduction is when a lender agrees to simply forgive some part of the mortgage loan balance. This is an enticing prospect to owners who are “upside down” -- owing significantly more than their homes are worth on today’s market.
Though many loan modification services swear that they can get borrowers’ balances reduced, this may be a real estate fairy tale. The New York Times recently reported that only about 1.3 percent of all successful loan modifications include a reduction of principal. There is virtually no incentive for a mortgage lender to agree to principal reduction, as it locks in their losses from the down market and allows you to reap 100 percent of the benefits when the market recovers.
While homeowners may be on an unrealistic mission to have their principal balances reduced, a lender’s sole goal for agreeing to modify a loan is to make the loan affordable on a long-term basis, so that the delinquent borrower will get and stay current on their mortgage payments. Additionally, there is evidence that over 50 percent of mortgages that are modified end up in default again! As such, lenders tend not to modify mortgages in cases where the borrower cannot prove they will be able to make the modified payment.
Are you a Good Candidate for Loan Modification?
Whether an individual homeowner’s mortgage will be modified is 100% subject to the lender’s discretion. Currently, every lender has a different set of criteria and guidelines governing whether they will modify a mortgage, and each lender has their own process that must be followed to apply for a modification. The lack of standards and the fact that the guidelines for granting a modification are murky, at best, has created a lot of confusion among even savvy homeowners. Often, borrowers seeking to modify their mortgages grow frustrated with the process, citing:
- the unwillingness of the lender to even discuss a modification unless and until the borrower falls behind on their payments, damaging their credit;
- the many, confusing logistical hoops they are asked to jump, including repeated lender requests for the same information, and frequently unreturned calls; and
- the fact that their modification requests are denied without explanation, despite their strong interest in keeping their home and willingness to make a reduced payment.
Good candidates for modification are homeowners who (a) have a valid reason that they fell behind in the first place, like a change in their income or a change in the payment amount, and (b) can document sufficient income to make the agreed-upon post-modification payments. Lenders don’t modify loans for people who can’t afford to make the payments they are agreeing to. Loans with interest rates and/or payments that have adjusted or are set to adjust soon are good candidates for modification.
Unfortunately, lenders are more likely to modify loans for borrowers who are late on their mortgages (but not so late that the foreclosure auction is set for tomorrow!), and the companies most likely to grant modifications are the lenders who have gone under and been bought out. Also, loan servicing companies seem to be tougher to secure mortgage modifications from than mortgage banks.
The Evolution of Loan Modification
The lack of standards and incentive for lenders to modify mortgages are primary issues addressed by the Obama Administration’s $75 billion foreclosure mitigation plan, announced on February 18th. Key elements include:
- providing incentives for lenders to more aggressively reduce homeowners’ mortgage payments,
- rewarding lenders who modify loans of borrowers who are current on their mortgage payments,
- rewarding homeowners who receive modifications and stay current on their mortgages, and
- creating a single industry standard for processing and granting loan modifications.
This plan is set to take effect on March 4, 2009, and holds the potential to make the loan modification process more transparent and feasible for many homeowners.