Loan Mod - Is It Worth It?

'Blown Mortgage' again has a good piece on what many people have experienced with the loan modification program, but more importantly how the banks are using it to further increase the indebtedness of the borrower.

If you'll recall, a few weeks ago I posted the financial calculations and reasoning behind a loan modification (January 5, 2010 - NPV). Borrowers must use similar calculations to their benefit in estimating the true cost and value of the modified loan agreement to which they are agreeing.

Loan Modifications Are They Worth It – An Overview In Simple English

by Andrew on January 28, 2010

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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.

Walk Away from the Underwater House

We are fortunate in California that we live in a non-recourse state. Read below what this means to you.

Walking away isn't always the answer, there are many choices available. I prefer the ones that allow my clients to reposition their Balance Sheet and turn it into a 'positive' rather than 'negative' statement of net worth.

Banks Seek Payback from Walkaways

Increasingly aggressive mortgage lenders are seeking to collect deficiencies from former home owners who walked away from their properties or sold them in short sales.

Many states, including Florida, give mortgage holders as long as five years to seek a deficiency judgment. If granted, the bank gets up to 20 years to collect and the option to renew for another 20 years if the debt isn’t paid.

About one-third of U.S. states, including California and Arizona, prohibit collection efforts after foreclosure, but home owners usually waive that protection in a refinance.

Most states allow collection on unpaid home-equity loans.

Banks are most likely to try to collect from people who walk away from a property on which they are still making payments.

“The bank is going to pull your credit report, and if you’re current on your other bills they are going to come after you and potentially ruin you,” said Larry Tolchinsky, a Florida real estate attorney.

Source: Bloomberg,

Probably the one most often heard statement since the collapse of the real estate market in 2006 I've heard has been, 'Let the banks write down those loan balances!' This notion is now taking hold, as the article below reflects.

Once you read it, you'll see that any other measely effort towards loan modification is senseless. This is something the banks, which are fully backed up by Treasury, should do quickly and without hesitation.

from Blown Mortgage...

Loan Modification consultants have being saying it for a long time; the best loan modifications are those that reduce the balance of the loan. This might seem obvious; of course borrowers are going to prefer loan modifications that reduce the amount they owe. What is not so obvious is that these types of loan modifications may be the best kind for lenders too.

Loan Modifications can use a variety of tools and measures to reduce the monthly payments of a mortgage. Reducing monthly payments is considered to be the main objective of a loan modification, as a way of giving troubled borrowers a break so they can continue to pay their mortgage. This can be done by:

1) Reducing the interest rate of the mortgage, either temporarily or permanently.
2) Extending the term of the loan, which means giving the borrower longer to pay the loan back.
3) Rolling interest payments to the end of the loan, this reduces monthly payments but creates a huge payment at the end of the loan.
4) Principal reductions of the loan balance. Here the bank or lender “forgives” or writes off a portion of the loan.

The Obama Administration does not control which measures lenders use on loan modifications and they certainly don’t require lenders to cut mortgage principals, what’s more, until recently principal reductions seemed unthinkable, a nice idea but not very practical. It must be said that forgiving debts is a nice thing for friends to do, but it doesn’t sound like a good way for lenders to do business.

However, recent reports are showing that principal reductions could be a key factor in creating cost efficient loan modifications for both lenders and borrowers. One of these reports was published by the Lender Processing Services June 2009 Mortgage Monitor and concluded that re-defaults on loan modifications with a principal reduction element fare much better than those based exclusively on interest rate reductions. The report states that “the success rate for loss mitigation-related loan modification hovers in the 30-40% range, with a higher success rate for loan modifications involving a reduction in unpaid balance.

The success rates of loan modifications with principal reductions is so much better than with other methods that lenders are beginning to listen to the data and increasing their principal reductions on mortgages of troubled borrowers.

You might still ask yourself why banks or lenders would be willing to cut unpaid loan balances instead of using other apparently cheaper measures. The key, we hinted at above, are foreclosures. Foreclosures are expensive for lenders, selling in a buyers’ market and the costs associated with selling a property are not cheap. Having said that any kind of loan modification carried out to avoid foreclosure is expensive for lenders whether they reduce interest rates, extend the term of the loan or reduce the principal balance, what makes it even worse is when borrowers re-default on their loans after the loan modification. Because foreclosure re-defaults are much lower on loan modifications with principal reductions, lenders are starting to think they might be cheaper in the long run, which is good news for the fortunate few that actually qualify for a loan modification.

The Secret is Out on Being Underwater with Your Loan

A great article follows that challenges the wisdom being used to 'solve' the present real estate fiasco that continues into it's 4th year (2010). Ask yourself what your 'moral stance' is on defaulting on loans you've taken out, and please feel free to post it here.

Also, if you'd like a copy of the U of AZ research paper, let me know and I'll forward a copy. The times are interesting...and they are 'a-changing'!

January 24, 2010

Economic View

Underwater, but Will They Leave the Pool?

By RICHARD H. THALER

MUCH has been said about the high rate of home foreclosures, but the most interesting question may be this: Why is the mortgage default rate so low?

After all, millions of American homeowners are “underwater,” meaning that they owe more on their mortgages than their homes are worth. In Nevada, nearly two-thirds of homeowners are in this category. Yet most of them are dutifully continuing to pay their mortgages, despite substantial financial incentives for walking away from them.

A family that financed the entire purchase of a $600,000 home in 2006 could now find itself still owing most of that mortgage, even though the home is now worth only $300,000. The family could rent a similar home for much less than its monthly mortgage payment, saving thousands of dollars a year and hundreds of thousands over a decade.

Some homeowners may keep paying because they think it’s immoral to default. This view has been reinforced by government officials like former Treasury Secretary Henry M. Paulson Jr., who while in office said that anyone who walked away from a mortgage would be “simply a speculator — and one who is not honoring his obligation.” (The irony of a former investment banker denouncing speculation seems to have been lost on him.)

But does this really come down to a question of morality?

A provocative paper by Brent White, a law professor at the University of Arizona, makes the case that borrowers are actually suffering from a “norm asymmetry.” In other words, they think they are obligated to repay their loans even if it is not in their financial interest to do so, while their lenders are free to do whatever maximizes profits. It’s as if borrowers are playing in a poker game in which they are the only ones who think bluffing is unethical.

That norm might have been appropriate when the lender was the local banker. More commonly these days, however, the loan was initiated by an aggressive mortgage broker who maximized his fees at the expense of the borrower’s costs, while the debt was packaged and sold to investors who bought mortgage-backed securities in the hope of earning high returns, using models that predicted possible default rates.

The morality argument is especially weak in a state like California or Arizona, where mortgages are so-called nonrecourse loans. That means the mortgage is secured by the home itself; in a default, the lender has no claim on a borrower’s other possessions. Nonrecourse mortgages may be viewed as financial transactions in which the borrower has the explicit option of giving the lender the keys to the house and walking away. Under these circumstances, deciding whether to default might be no more controversial than deciding whether to claim insurance after your house burns down.

In fact, borrowers in nonrecourse states pay extra for the right to default without recourse. In a report prepared for the Department of Housing and Urban Development, Susan Woodward, an economist, estimated that home buyers in such states paid an extra $800 in closing costs for each $100,000 they borrowed. These fees are not made explicit to the borrower, but if they were, more people might be willing to default, figuring that they had paid for the right to do so.

Morality aside, there are other factors deterring “strategic defaults,” whether in recourse or nonrecourse states. These include the economic and emotional costs of giving up one’s home and moving, the perceived social stigma of defaulting, and a serious hit to a borrower’s credit rating. Still, if they added up these costs, many households might find them to be far less than the cost of paying off an underwater mortgage.

An important implication is that we could be facing another wave of foreclosures, spurred less by spells of unemployment and more by strategic thinking. Research shows that bankruptcies and foreclosures are “contagious.” People are less likely to think it’s immoral to walk away from their home if they know others who have done so. And if enough people do it, the stigma begins to erode.

A spurt of strategic defaults in a neighborhood might also reduce some other psychic costs. For example, defaulting is more attractive if I can rent a nearby house that is much like mine (whose owner has also defaulted) without taking my children away from their friends and their school.

So far, lenders have been reluctant to renegotiate mortgages, and government programs to stimulate renegotiation have not gained much traction.

Eric Posner, a law professor, and Luigi Zingales, an economist, both from the University of Chicago, have made an interesting suggestion: Any homeowner whose mortgage is underwater and who lives in a ZIP code where home prices have fallen at least 20 percent should be eligible for a loan modification. The bank would be required to reduce the mortgage by the average price reduction of homes in the neighborhood. In return, it would get 50 percent of the average gain in neighborhood prices — if there is one — when the house is eventually sold.

Because their homes would no longer be underwater, many people would no longer have a reason to default. And they would be motivated to maintain their homes because, if they later sold for more than the average price increase, they would keep all the extra profit.

Banks are unlikely to endorse this if they think people will keep paying off their mortgages. But if a new wave of foreclosures begins, the banks, too, would be better off under this plan. Rather than getting only the house’s foreclosure value, they would also get part of the eventual upside when the owner voluntarily sold the house.

This plan, which would require Congressional action, would not cost the government anything. It may not be perfect, but something like it may be necessary to head off a tsunami of strategic defaults.

Richard H. Thaler is a professor of economics and behavioral science at the Booth School of Business at the University of Chicago.

This month the consumer is being rewarded with the results of many new rules and regulations. There are changes in how credit card companies bill you and charge interest, how banks can take your money for the smallest of services, and of course, we have many new rules for both real estate and lending.

OK, some of these are good, indeed. Others are but chimera. A good regulation deals with loan and real estate closing cost comparison, which will make us all better shoppers. Here is an enlightening article along those lines.

New RESPA Regulations Make It Easier to Shop for Closing Services

RISMEDIA, January 11, 2010—Consumers will no longer be left in the dark about the closing costs involved to complete the sale or purchase of a home- costs that account for an average of 5% of the purchase price.

Changes in the Real Estate Settlement Procedures Act (RESPA) that took effect on January 1, 2010 require lenders to fully disclose all closing costs including the costs of obtaining a loan

Loan Modifications - The Underlying Truth for January 2010

Last month, last year, last decade I wrote about the actual financial mechanics involved in getting a loan modification...not on your part but on the behalf of the lender. In the end it is the lender that matters most, and if the numbers do not work out you won't get a workout on your loan (although you'll get quite a run around working arduously with the lender to no avail).

Here is a follow up post on NPV (Net Present Value) and what you should know about it. You'll see that the bottom line is that you have little say in the valuation process:

NPV Test, Your Personal Loan Modification Sword of Damocles

(from Blown Mortgage)

Understanding the factors that control the success or failure of your loan modification is vital if you want any chance of receiving a positive modification to your mortgage. Loan Modifications are not happening very fast and the modification rates for troubled homeowners are very low.

The reasons for this are many because loan modifications are complex and depend on a number of variables. Borrowers may fail to fill in paperwork, applications get lost in the process, banks and servicers drag their corporate feet and sometimes loan modifications are just bad business for lenders and must be dropped.

Determining if a loan modification makes financial sense to a lender is the purpose of the NPV (Net Present Value) test. It pays to understand how this test works because anybody that fails it has their loan modification automatically cancelled.

Why have an NPV test?

The purpose for the NPV test is to guarantee a loan modification is profitable in the long term for banks and servicers. The test is made up by an algorithm that takes into account various factors that will determine the behavior and attitude of the borrower, the price of the house and the ability of the borrower to pay the modified loan payments.

The exact form of the algorithm is kept secret to stop borrowers from trying to rig the test. The test measures the likelihood of a borrower from re-defaulting on their mortgage. This is determined by the income of the borrower and the reasons the borrower has to stay in the house. For example if a single borrower is stuck with an underwater house and has no ties with his current neighborhood he or she is going to get a much lower rating than a family with two children that moved to be closer to their aging parents.

An important part of the NPV test calculates the current value of the house. This takes into account the cost of foreclosure and the expenses related to selling the property. Once the “deducted” or real value of the house is determined it is compared with the return the bank would get from a modified loan. If the lender does not benefit from the loan modification it is automatically revoked.

How to help your chances to pass your mortgage´s NPV test?

The NPV test mainly deals with facts and figures that are hard to influence, unless you lie, but there is still much you can do to improve your chances of passing.

It is important to create a solid case that proves you are highly motivated to stay in your house. One of the biggest costs of loan modifications is that after all the work, time and money invested borrowers often re-default bringing on the borrower all the costs of foreclosure he was hoping to avoid with the foreclosure.

This can be done by giving good reasons why you will stay in your house whatever happens, even if it is underwater and does not seem like a great investment at the moment.

The valuation of your mortgage is a very important part of your NPV test. You cannot do much to control the valuation but federal valuation projections change every quarter so if you failed your NPV test one quarter it is worth doing it again the next if you still have time.

A final step you can take is to provide evidence of why you can´t afford the current mortgage payments. Loan modifications are expensive as they include reducing interest, often for the lifetime of the loan, so banks need to make sure they are not providing loan modifications to borrowers that could afford their current loan payments with a little bit of effort and good old fashioned frugality.