Loan Modifications Explained

With all the talk in recent months about financial stimulus and bailouts, a new term has come to the forefront of homeowner’s vocabulary: loan modification. But what exactly does the term mean, and what do loan modifications entail?

Whether you call it a loan modification, mortgage modification, restructuring, or workout plan, it’s when a borrower, one who is facing great financial hardship and is having difficulty making their mortgage payments, works with their lender to change the terms of their mortgage loan. The modification could result in temporary or permanent changes to the mortgage rate, term and monthly payment of the loan. The goal is to help the borrower reduce their monthly mortgage payments to 31% of their gross income. Under Obama’s “Home Affordable Refinance” plan, loan modifications will be standardized, with uniform loan modification guidelines used by Fannie and Freddie Mac, and then they will be implemented throughout the entire mortgage industry.

So who, you may ask, is eligible for a loan modification? According to the Department of Treasury, anyone with high combined mortgage debt compared to income, or who has a combined mortgage balance higher than the current market value of his house, may be eligible for a loan modification. This initiative will also include borrowers who show other indications of being at risk of default. The Home Affordable Refinance program will be available to 4 to 5 million homeowners who have a solid payment history on an existing mortgage owned by Fannie Mae or Freddie Mac. Normally, these borrowers would be unable to refinance because their homes have lost value, pushing their current loan-to-value ratios above 80%.

Under the Home Affordable Refinance program, many of them will now be eligible to refinance their loan to take advantage of today’s lower mortgage rates or to refinance an adjustable-rate mortgage into a more stable mortgage, such as a 30-year fixed rate loan.This program applies to borrowers who are unable to make — or are struggling to make — mortgage payments that exceed 38% of their monthly income. If the lender agrees to lower the interest rate or reduce the principal amount to bring the payment to 38% of the borrower’s income, the government will pay half of the additional cost to the lender to reduce the payment to 31% of the borrower’s income.

Who’s not eligible for a loan modification? Speculators, or borrowers who bought homes for investment purposes. All homes must be owner-occupied. Also, mortgages with amounts above the conforming loan limits would not be eligible.

Eligibility and Verification

• Loans originated on or before January 1, 2009.

• First-lien loans on owner-occupied properties with unpaid principal balance up to $729,750. Higher limits allowed for owner-occupied properties with 2-4 units.

• All borrowers must fully document income, including signed IRS 4506-T, two most recent pay stubs, and most recent tax return, and must sign an affidavit of financial hardship.

• Property owner occupancy status will be verified through borrower credit report and other documentation; no investor-owned, vacant, or condemned properties.

• Incentives to lenders and servicers to modify at risk borrowers who have not yet missed payments when the servicer determines that the borrower is at imminent risk of default.

• Modifications can start from now until December 31, 2012; loans can be modified only once under the program.

How does someone get a loan modification?  The details of the plan, released on March 4, are as follows:

• Participating servicers are required to service all eligible loans under the rules of the program unless explicitly prohibited by contract; servicers are required to use reasonable efforts to obtain waivers of limits on participation.

• Participating loan servicers will be required to use a net present value (NPV) test on each loan that is at risk of imminent default or at least 60 days delinquent. The NPV test will compare the net present value of cash flows with modification and without modification. If the test is positive, meaning that the net present value of expected cash flow is greater in the modification scenario, the servicer must modify absent fraud or a contract prohibition.

• Parameters of the NPV test are spelled out in the guidelines, including acceptable discount rates, property valuation methodologies, home price appreciation assumptions, foreclosure costs and timelines, and borrower cure and redefault rate assumptions.

• Servicers will follow a specified sequence of steps in order to reduce the monthly payment to no more than 31% of gross monthly income (DTI).

• The modification sequence requires first reducing the interest rate (subject to a rate floor of 2%), then if necessary extending the term or amortization of the loan up to a maximum of 40 years, and then if necessary forbearing principal. Principal forgiveness or a Hope for Homeowners refinancing are acceptable alternatives.

• The monthly payment includes principal, interest, taxes, insurance, flood insurance, homeowner’s association and/or condominium fees. Monthly income includes wages, salary, overtime, fees, commissions, tips, social security, pensions, and all other income.

• Servicers must enter into the program agreements with Treasury’s financial agent on or before December 31, 2009. Also depending on the direness of your financial difficulties, it’s always good to hire legal counsel. Get a referral from your local state bar association. Or, call a local HUD-Approved Housing Counseling Agency for guidance.

One word of warning: This new bill has spawned a whole new wave of loan modification salespeople who might be perfectly fine, and some who are not. Be careful. You can find loan modification available through your existing lender, or call us at The Bremner Group to receive a qualified referral.

Why would lenders modify your loan? Incentives. According to USA Today, the plan also includes incentives to encourage mortgage servicers, who collect fees for refinanced and delinquent mortgages, to work with qualified borrowers to modify loans. Servicers will get $1,000 for each eligible modification they make, and another $1,000 a year for three years as long as the homeowner remains current on payments. Homeowners who stay in their properties and are current will get a monthly balance reduction to help reduce their loan principal. That will amount to up to $1,000 a year for five years. Also, banks would rather have you stay in your home, rather than have the house go to foreclosure. They stand to lose more if you foreclosure than if your loan is modified.

Bottom line: The “Making Home Affordable” plan will offer assistance to as many as 7 to 9 million homeowners, making their mortgages more affordable and helping to prevent the destructive impact of foreclosures on families, communities and the national economy.