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Jack M. Guttentag The Mortgage Professor

Loan Modification: What You Should Know, Part One

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Very Good (78 Ratings): 3.358974/5

Posted on Tuesday, October 9, 2007, 12:00AM

A loan modification is a change in the loan contract agreed to by the lender and the borrower. The modifications of major concern today are those designed to reduce the payment burden on borrowers faced with impending rate increases that will make the mortgage payment unaffordable to them. Many are subprime borrowers.

Home owners faced with this prospect, whether they are already delinquent or not, should request a modification. They are very unlikely to get one if they don't ask, and they should make the investment required to make their case. The stakes are very high: They can save their house and their credit.

The Decision Process

In most cases, the decision on a modification is not made by the firm that owns the loan. It is made by a firm servicing the loan under contract to the owner. The owner could be a single lender, or it could be a group of investors who own pieces of a mortgage-backed security collateralized by a pool of loans.

Whoever the owner, the servicing firm is contractually obligated to find the solution to payment problems that will minimize loss to the owner. If the lowest-cost solution is a contract modification, great -- everyone involved prefers a modification to a foreclosure. But if a foreclosure would generate lower costs for the owner, the decision will be to foreclose. The cost of foreclosure to the borrower does not enter the decision.

Yet the decision is far from cut and dried, and it can be materially affected by whether and how the borrower presents his case. On this issue, I have benefited from an exchange with Warren Brasch, an attorney who represents borrowers seeking loan modifications.

The Equity Factor

Perhaps the most important factor affecting the modification decision is the amount of equity the borrower has in his property. If the borrower has enough equity in the property to pay any deferred interest plus foreclosure expenses, foreclosure is usually the lower-cost solution.

Equity depends on property value, which the borrower is much better positioned to know than the servicer. The borrower knows or can easily find out how many houses in the neighborhood are for sale and what the trend has been in recent sale prices. In a weakening market, it is easy for the lender to overestimate value, and the borrower must prevent that.

The Moral Hazard

Servicers fear that, if they are liberal in granting modifications, borrowers who don't need a modification will seek one anyway. They protect themselves against this by entertaining modification proposals on a case-by-case basis, while placing the burden of proof on the borrower.

Borrowers must accept the burden of proof. In addition to the data on property value, they need to document that they cannot afford the payment increase that is pending, and they must document exactly what they can afford.

For this purpose, borrowers should calculate their total debt ratio: the sum of mortgage payment, other debt payments, property taxes, and homeowners insurance as a percent of their gross (before tax) income. This number should be calculated for what it is now, what it will be after the rate adjustment, and what they will be able to afford. On the last, Brasch suggests that a servicer may be willing to accept 45 percent as a reasonable maximum.

The Servicing Cost

Servicers have a self-interest in minimizing modifications, because they add to costs. They try to minimize costs by computerizing the servicing process to the maximum degree possible and standardizing customer-support procedures so that low-paid and easily trained employees can perform them.

Modifications must be handled by a special group that is more highly trained and better paid, and the increased costs from expanding their number cuts into the bottom line. Hence, there is a tendency to be non-responsive in the hope that the borrower will go away.

Borrowers have to be persistent. According to Brasch, "If a servicer says they will call you back...forget about it. You need to call them and call them constantly. They will lose your paper-work, fail to return calls, put you on hold, and then hang up. It's what they do. Keep fighting, calling, faxing. This does work!"

In making their decisions about whether a modification would be less costly than a foreclosure, servicers usually ignore an asset possessed by the borrower that could tilt the balance toward modification. This is the right to future appreciation in the value of the borrower's house. In exchange for a modification that might otherwise be more costly to the owner than a foreclosure, the borrower could pledge a percent of the future appreciation, which could shift the balance to modification. This will be discussed in the second article in this series.

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23 Comments

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wealthencyclopedia.com - Saturday, November 24, 2007, 1:42PM ET Report Abuse
- Overall: 4/5
Good article. Sad story in general - but in the end, nobody forced these people to sign on the dotted line. Gotta read the fine print.
Dave Q - Monday, November 19, 2007, 1:48PM ET Report Abuse
- Overall: 2/5
The article touches on several interesting points. But like the old adage: "You get what you pay for". Many people wanted a home so desparately that they were willing to sign up for anything that would give them the feeling of "living the American Dream". Why? Did we all forget the fact that prior to the 2004 - 2006 home market boom period, that many people were losing faith in the economy and the country was starting to enter a quasi recession. The subprime market created jobs for many people who didn't have any and secondary incomes for those who did. But I digress. What really happened was buyers were not doing their due diligence...they just acted as if they were purchasing a garment or a book from a store and if they didn't like the way the garment fit or found that the book had missing pages, they could just take it back and get a refund. They forgot that a home is not a purchase but an investment! So taking a "stated" or "ARM" deal not knowing the ins and outs of it, with the purchase mentality, the buyer is the one ultimately at fault. "Ignorance is not an excuse to disobey the law". This statement is true and is exactly what buyers did...they ignored the laws of their logic and now they are paying for it. But there is still some hope on the horizon. FHA has recently made many changes in their requirements in order to help the over 2 million homeowners expected to be foreclosed upon over the next 12-18 months keep their homes. Maybe buyers should look to save their "investment" by contacting lenders that have FHA status for lending. This can not only save their home but possibly give them hope. Contacting the lender that a buyer used to acquire their property may no longer exist and chasing down the new note holders can become confusing and fustrating at best. It would be easier if you have enough equity in the home to just refinance with an FHA approved lender. Yes it will cost you some money but would you rather have a foreclosure on your already depleting credit report for the next 12 - 24 months and still not be able to get a loan after that? I think not !!!
nchavezjr - Tuesday, October 16, 2007, 11:55AM ET Report Abuse
- Overall: 2/5
Well, this article just says to call your lender and to keep calling...lol Getting documentation of what you can afford is good advice... I know many will lose their homes because they overextended themselves, lied on applications and lenders didn't verify anything.... its the lenders fault for accepting "stated" applications... and the borrowers fault for overextending themselves in hopes to refi in 3 or 5 years... the people with the 2yr fixed ARMs, I have no sympathy for them, that is simply speculative investors wanting the American dream, what a joke! ARMs were meant for people who wanted to put their money on higher yeilding investmensts, but if needed, could pay if and when the ARM reset, not for those who couldn't buy properties unless they used an ARM loan.....
Yahoo! Finance User - Monday, October 15, 2007, 7:43PM ET Report Abuse
- Overall: 5/5
I've been buying houses (predominantly as primary residences) for nearly 18 years. During that time, paperwork during signing has increased so much so, that even I sometimes skim through the docs without reading every word. I know what to look for, though. How many people didn't? I know of many mortgage brokers and loan officers that encouraged folks to sign-up for the sub-prime ARM's in the boom. Not everyone in the industry had or has scruples, and they did want to make a buck. I think the responsibility should be shared amongst the lenders who pushed the sub-prime mortgages and allowed the no-doc loans, the borrowers who sometimes lied about their income, and all of the support personnel (title, appraisers, real estate agents, attorneys, etc.). I am glad to know that people who are truly in trouble, people that are at risk of losing their primary residence, have another option in addition to short sale or foreclosure. Folks that are at risk of losing an investment, well, that's exactly what they took when they invested, a RISK, just like investing in the stock market or opening a small business. I believe it is difficult to characterize everyone in one group, and I think arguing about this issue that "all people" belong in one group or another is fruitless. Bottom line, if someone has the intelligence and tenacity to do their homework and the work behind saving their home, I applaud their efforts for contacting their mortgage servicer to see about a modification. It is also a guarantee that the more foreclosures and short sales in a market and/or particular neighborhood, the more the overall value in a market will fall, especially without legitimate sales to back up the appraisals.
Yahoo! Finance User - Monday, October 15, 2007, 4:42PM ET Report Abuse
- Overall: 3/5
You people blaming the average Joe investor are way off the mark. Its like saying the people who put their life savings into the stock market in early 1929 had no reason to blame the irresponsible brokers who were predicting huge gains and clear sailing. In fact, this situation is dangerously close to that same scenario - for different reasons. As with any societal mystery there is but one way to find the answer - follow the money. Who stood to gain from average people pouring money into the stock market in 1929 (or 1999) and into the real estate market now? Same people. All you free marketers out there take heed. This is a new age of monopolies and snake oil salespeople. Everywhere you look some unscrupulous "professional" is looking to grab your money. I've got money to invest in a house right now, but I'm leaning towards not doing it. I have a sneaking suspicion that it would be a bad investment. Just like the apartments my great-grandfather bought in 1928. Lost all of them in two years, ended up selling the farm and crowding two families into a 3 bedroom apartment (renting). I'm outta here, hope all you have fun paying 100 dollars for cable tv/internet, 150 for car insurance, 150 for health insurance, 300 for car payments, not to mention the ridiculous amounts of income tax, social security tax, medicare tax, property tax, state income tax, state sales tax etc, etc, etc. You people who think us average Joes complain too much should wake up and realize that most of us work 60-80 hours a week (with no overtime compensation because its in two jobs) and spend over 80 percent on bills. Have fun in your new third world country. You are responsible for it. You are the ones hiring illegal workers. You are the ones taking out junk bonds to pay for debt run up by corrupt business/political leaders. Baby Boomers are the most selfish, naive, hypocritical bunch of locusts to ever plague ANY nation in history. Congratulations! Way to take our country from world prominence/respect (earned with your parents' blood) and turn it into a circus.

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