Loan modifications will help more owners keep their homes

We've been able to help several owners in financial distress stay in their homes, when they are faced with financial distress, job uncertainty or falling property values. When owners call us to ask for advice on the best strategy for their situation, our answers vary.
If a homeowner has lost their job or is not determined to stay in their home, we suggest investigating short sales and bankruptcies, while obtaining legal advice on both options. If an owner can't make their payments anymore, it may be hard for them to keep their house. If a short sale (a sale that involves the lender accepting less than what is owed) is an option for an owner, we have the owner put together a financial package to share with the lender(s) and start marketing the property for offers, subject to lender approval. A short sale can help owners stay in their homes, even if they are behind on their payments. A short sale may help postpone an auction date, which allows owners more time in their homes. A short sale has a very similar effect as a foreclosure on a credit report, but sources say a short sale may prevent you from buying a home for 5 years vs. a foreclosure which would be a 7 year period. A short sale may read "paid less than owed" vs "foreclosure", but both are damaging to one's credit rating. Bankrupcy may be an option, if you need to wipe out more debt than just your home.

If a homeowner is facing mounting debt and an inability to continue paying their mortgage, our first question is whether they want to stay in their home. Most answer, "Yes, I want to stay in my house." In this case, we encourage owners to consult with their lenders to see if a loan modification can help resolve their issue. Many times a lender will reduce the interest rate or turn an ARM into a 30 year fixed, to make the payments lower for the homeowner. Many owners call us back and tell us the lenders are unreceptive. Many lenders will initially say that you must continue to make your payments, or they will start the foreclosure process, if you fall behind. Lenders also tell these owners, who usually are in good credit standing and are current on their mortgages, that nothing can be done to modify their loans without the owner falling behind on their mortgage or demonstrating financial hardship. We tell owners to be persistent with their lender and keep their loans current, if they can. After several failed attempts, owners usually call us back and say that their loans have been successfully modified. The point here is that you can't give up after one phone call. Continue calling and calling and calling until the lender agrees to do a loan modification. Lenders don't want your house back. You just have to be persistent and demonstrate that you are being financially-responsible by taking action before missing loan payments.

In a recent article from cnn.com, the topic of loan modification is discussed further:
One failed bank gets the housing fix right

By Amanda Gengler, Money Magazine writer

NEW YORK (Money) -- The battered economy is in desperate need of a housing fix, and one failed bank just may have the answer.

On Thursday FDIC Chairwoman Sheila Bair told the Senate Banking Committee about the success her agency has had in helping struggling borrowers at IndyMac, which the FDIC took over this summer.

Bair, the nation's leading bank regulator, thinks this foreclosure prevention program can work for other banks.

"Our hope is that the program we announced at IndyMac Federal will serve as a catalyst to promote more loan modifications for troubled borrowers across the country," she told the committee.

She's not alone. While individual lenders, loan servicers and non-profit foreclosure prevention outfits have been chipping away at the staggering housing crisis on a case by case basis, IndyMac, under the FDIC's leadership, became the first bank to establish a set protocol to modify home loans.

Speeding the process
"I think this is an appropriate way to go, and I would hope that more institutions would take it up," said Michael Barr, professor of law at University of Michigan and a senior fellow at the Center for American Progress. "We need a systematic way to do this, we can't continue to do this on a one-by-one basis."

Chris Kukla, senior council for government affairs at the Center for Responsible Lending, points out that this is precisely how Congress approached the recent Wall Street bailout.

"We aren't sitting down on an individual basis and figuring out who needs what," he said. "The government is giving a piece to everyone because there is a recognition that we need to stabilize the financial markets. Well, we need to stabilize the housing market too."

IndyMac services more than 60,000 loans that are either more than 60 days past due, in bankruptcy, in foreclosure or are otherwise not currently being paid. About two-thirds of those customers are eligible for the program, according to Bair, and more than 3,500 IndyMac borrowers have had their loans modified to affordable levels so far. Borrower payments have been cut on average by $380, she said.

Currently most lenders assess each loan on a case-by-case basis, which takes a tremendous amount of time and resources, and can hold up the process for months. Establishing set rules that a lender can apply to thousands of borrowers will speed the process, and help right the housing market more quickly

Under IndyMac's program, the lender modifies a loan so that the borrower's new mortgage payment, including insurance and taxes, eats up no more than 38% of their pre-tax income. This percentage, known as a debt to income ratio, topped 50% for some loans during the boom.

To achieve this lower payment, IndyMac can lower the interest rate, extend the life of the loan to, say, 30 or 40 years, defer some principal to the final years of the loan, or a use a combination of these strategies.

IndyMac is also trying to simplify the process for borrowers. It is overnighting loan forms to eligible customers with a signature required upon receipt. "It doesn't show up with your regular mail, coupons and junk mail, because the key is getting the consumer to open it," said FDIC spokesman David Barr.

The papers clearly spell out a borrower's new loan terms, including the interest rate and monthly payments over the life of the loan. The borrower simply signs and returns the documents with the first lower monthly payment.

B of A follows suit
Bank of America (BAC, Fortune 500) launched a similarly systematic program earlier in October. That program, scheduled to start in December, came as part of a settlement with state attorney general offices that sued Countrywide, which B of A recently acquired, for predatory lending practices. It's expected to help 400,000 troubled borrowers and is actually slightly more aggressive than IndyMac's plan.

B of A will use a 34% debt-to-income ratio to calculate the affordable monthly payment for its customers, and may also write down the principal balance of some negative amortizing loans. IndyMac will not forgive debt, but instead will add principal to the final years of a loan if necessary.

Additionally, IndyMac's program is now being applied to many delinquent loans owned by Freddie Mac (FRE, Fortune 500), Fannie Mae (FNM, Fortune 500) and other investors, Bair said in her testimony Thursday.

Not everyone is convinced that Bair's brainchild should be the industry-wide template.

Thomas Lawler, a housing economist in Leesburg, Virginia, contends that lenders need to look at a borrower's other assets in addition to their debt to income ratio before working out a loan. "Otherwise, they will include people who shouldn't really qualify, and might exclude people who do," he said. "That is one reason why mortgage lenders don't particularly like to have a very simple systematic streamlined modification, because it doesn't work."

For example, a borrower with substantial additional assets and no other debt may have taken out a big mortgage that eats up 45% of his income. There is a risk that the program will aid this borrower, and not someone with a smaller mortgage and no other assets who also has student and car loans.

But the Center for Responsible Lending's Chris Kukla argues that the crisis is too severe to worry about helping people who don't deserve aid.

Indeed, earlier this month The State Foreclosure Prevention Working Group, a group of state attorneys general and banking regulators, sent a letter to nearly 20 of the largest servicers telling them that they were expected to implement a systematic approach to modify loans similar to IndyMac and Bank of America.

"We aren't getting push back yet, but we haven't gotten any firm commitments yet either," said Iowa Attorney General and task-force chair Tom Miller. "But there is a willingness to talk."

"This is the best idea out there to stop the bleeding in subprime lending," Miller said. "We think it is the best thing we can do at this point."

First Published: October 24, 2008: 2:15 PM ET