Finance Industry News

Consumers seeking information on loan modification programs can easily become confused with the apparent multiplicity of options. Many homeowners are already unsure of exactly what a loan modification is and how it might work, so trying to compare mortgage rates or refinance rates as part of a loan modification can be challenging.

While there are a variety of loan modification programs with somewhat different “sponsor” names, they all employ the same basic provisions. You still need to understand how any loan modification program works to evaluate the benefits and potential downsides of this feature. Loan modifications are different from a typical mortgage refinance.

In theory (and practice), all loan modifications should accomplish two goals:

• Reduce potential losses facing mortgage lenders because of delinquent home loans. Local mortgage rates may or may not apply during loan modifications and because of delinquency.
• Allow homeowners, typically in dire financial circumstances, to resume on-time mortgage payments and keep their homes. Homeowners can protect their home equity with a proper modification.

By taking different actions, lenders modify the terms of the current mortgage to avert foreclosure processes and help borrowers get back on track by offering new, affordable terms. Understand that, historically, mortgage lenders consider loan modifications only while “kicking and screaming.” The bursting of the real estate “bubble” has forced lenders into entertaining loan modifications with more positive energy.

The intervention of the U.S. government is intended to simplify and codify the loan modification process by outlining specific rules to benefit both lender and borrower. However, whether all lenders are following the guidelines to the letter and intent is open to some strong discussion.

Common Provisions of the loan modification programs

The government-endorsed loan modification program, regardless of whether it’s adopted by the FDIC, FHA, Fannie Mae, Freddie Mac, or the White House, contains basic provisions that all lenders are expected to follow:

Determine a monthly payment that the borrower(s) can afford going forward.
The universal target of the government-endorsed loan modification is to reduce the monthly mortgage loan payment to a maximum of 38% of the borrower(s)’ gross monthly income. To accomplish this goal, lenders should take one or more of the next listed actions.

Reduce mortgage rates, which lowers the monthly payment.
Lenders are expected to reduce the rate as much as possible, even down to 2.0%.

Extend amortization (term of loan) to lower monthly payment.
Increase the amortization up to 40 years if necessary to achieve the goal of affordability. A mortgage refinance that extends the term by up to ten years, combined with lower refinance rates, can save hundreds of monthly-payment dollars.

Agree to forbear (forgive and forget) principal for some period.
Forbearing principal for some period or forgiving some fixed amount of principal from the outstanding loan balance is the last resort for the lender to achieve the goal.

Use Net Present Value techniques to estimate future cash flow after the modification.
Estimating the projected cash flow after the modification and comparing it to the estimated cash flow if there is no modification verifies the wisdom of permitting the loan modification. The hope is that the cash flow after loan modification will be better for the lender than the costs of foreclosure.

How have loan modification programs worked to date?

The jury is still out on the success level of the loan modification program. There are a number of reasons that these programs don’t always work as efficiently as hoped. Local mortgage rates remain low, but a modification may require even below-market refinance rates.

Lenders are under strong pressure from executive management and shareholders to avoid loan modifications. Most modifications result – immediately or eventually – in “write downs” of the value of lender assets. Often the key factor addressed by the government-supported programs is to mitigate (lessen) the potential losses. When lenders see that approving a loan modification – even though interest rates decrease, loan terms extend, or principal is forgiven – results in a smaller loss than not executing the modification would, they should approve the plan.

Yet, sometimes their adoption of the programs remains cloudy. For example, a consumer-oriented law firm in Washington recently sued Bank of America on behalf of some borrowers, who maintain that the lender acted in bad faith by first refusing to modify and then delaying action on a loan modification request until the home was lost by the borrowers. Mortgage loans occupy a most sensitive place in the economy, which makes this suit noteworthy.

Borrowers sometimes fail to act in a timely manner or follow lender instructions properly, delaying or preventing loan modifications from occurring. For example, borrowers requesting loan modifications are often told to “do nothing” until they hear back from their lender. They sometimes follow these instructions too literally, often stopping monthly payments.

Lenders often tell borrowers they should hear “something” within 30 to 45 days, but then don’t respond for three or four months. While this is wrong, borrowers who cease sending monthly payments often generate more severe trouble for themselves, making loan modifications impossible.

These loan modification programs remain available. Their status can still be deemed questionable since there appears to be little consistency in implementation. There are incentives for both lender and borrower, which if used, offer cash ($1,000) payments for approving modifications (lenders) and for keeping monthly payments up to date (borrowers). Yet, it’s difficult to make a determination as to the success or failure of the program to date.