Loan Modification
First, a warning to California readers – it is illegal to take an advance fee to do a loan modification. You pay the person doing the loan modification AFTER the loan modification is obtained. If someone asks you for an advance fee to do a loan modification, call the Attorney General’s loan modification hotline at 800-952-5225.
Everyone reading this need to understand that obtaining a loan modification is an agreement between you and the loan servicers, not a right, and there is no obligation on the part of the loan servicers to give you one. No one can guarantee getting a loan modification. You also need to understand that getting a loan modification which reduces the principal owed is very rare an unusual due to the packaging and selling of loans to the financial market. You also need to understand that the goal of a loan modification is not to live in the house forever for free.
The first factor considered is the type of loan. A 30 year fixed rate loan at 3% is not going to be modified; regardless of the hardship or value of the home. The best results for a loan modification are (1) adjustable rate (2) pick a pay (3) option ARM facing reset. These loans all involve the monthly payment increasing significantly and the borrower losing their home.
The second factor is the borrower. The borrower must be able to afford making monthly mortgage payments on a sustained basis. If there is no household income, or the household income is low enough that the monthly payment makes no economic sense to the bank, the loan will not be modified.
Generally, the formulas used by the banks to determine if a borrower is suitable for a loan modification works something like this:
The key calculation is the debt to income ratio of your monthly household income divided by your mortgage payment. Your other payments, and whether your house is underwater, are less important. After doing this division problem, you end up on one of three bands:
- Debt to Income Ratio of less than 31%: this is below the federal HAMP loan modification threshold and the loan will not be modified.
- Debt to Income Ratio of 32 to 70%: depending upon the loan type and property value factor (a factor for you but not the bank) these loans can generally be modified.
- Debt to Income Ratio of above 70%: Regardless of how you crunch the numbers, loans with this debt to income ratio cannot meet government standards and the loan will not be modified.
The third factor is the value of the home. You need to consider the loan to value ratio of your home before requesting a loan modification. This is done by adding up the total amount owed on all the mortgages then dividing that number by the estimated market value of the home. You can obtain an estimate for this from a local realtor or from Zillow.com (in a flat market, their estimates are surprisingly accurate). If the loan to value of your property is more than 150% it may not make economic sense to modify the loan as property values are not likely to rise fast enough to make up the shortfall for several years.
You may also want to consider the location of the property as well. In outlying or remote areas, property prices will decline or remain flat for the foreseeable future, and your modified home loan payment may well be higher than the rent or purchase of a replacement home.
An example of this was a file we looked at for a home in Helendale, CA. Helendale is an area between the High Desert and the San Gabriel mountains along Route 66, west of Victorville, CA. Home prices in Helendale have simply imploded. A man consulted with us about doing a loan modification on a $300,000 mortgage. After doing some research, we discovered that a replacement home in his neighborhood, in fact a model match (the same floor plan on a different lot) was available for $50,000. He was better off banking the monthly payments to his bank and paying cash for a replacement home.
Principal reductions on loan modifications are a tricky issue. Normally, the first trust deed (generally the largest loan against the house) will not agree to a principal reduction; they are the ones who get the property back if a foreclosure takes place so there is no incentive. On second and third trust deeds, principal reductions can be quite common. They are eliminated if the first trust deed forecloses and they know it. It is quite possible to negotiate a second or third trust deed down to pennies on the dollar.
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