Types of Mortgage Mods

One big method used to thwart oncoming foreclosures is through mortgage modifications. Modifications are being pushed both on state and federal levels. Hoping that modifications tailored to the individuals issues and income can either forestall or entirely prevent another foreclosure. Whether you agree with this or not it definitely a political priority, and therefore a policy that is being pushed at all levels of government. We found an interesting post this morning over at Chicago 77 titled The Ugly Truth About Loan Modifications from Brad Walbrun, who is a mortgage consultant in the Chicago area. The post provides a lot of information (take a look) , but we will take a look at his description of the 4 modification types -

Tack it on the back A common one is for people who are behind in their mortgage payments right now, to take the past due and put it on the end of the loan. Let’s say somebody has a $200,000 mortgage, and is behind three payments at $1500 each. If there was a temporary reason the homeowner got behind, like a job loss, and now they are making income again, the bank can put the past due at the end of the loan and give the homeowner a fresh start.

Recasting If somebody had an adjustable rate mortgage (ARM) that went up after 2, 3, or 5 years, and the payment jumped up, the lender can “re-cast” the ARM for a longer period to keep the payment the same. Let’s say somebody had 5.5% on an ARM, and on the adjustment date it went up to 7.5%. Depending on the loan size, the difference can be hundreds of dollars monthly. This can obviously cause some hardship for the homeowner, especially if they are making less now than before, like much of the country is experiencing. What the bank might do in this case is either “fix” the rate for another 2 or 3 years so the payment stays the same, or just convert it into a fixed rate at the same rate. These types of modifications are almost always contingent on the homeowner having good payment history prior to the adjustment.

Debt forgiveness A third type is debt forgiveness or principal reduction. This is common in short sale scenarios. Let’s say somebody owned a house that was once valued at $300,000. They had 90% LTV financing for a loan amount of $270,000. And now they have to sell the house because of job relocation or because their income level has changed and they need to downsize. But the problem is that the house that was once worth $300,000 can now sell for only $240,000 (a 20% drop from peak value is not uncommon these days). The bank knows that if they have to foreclose on the house, it would sell at auction for much less than the $240,000, so they agree to accept a smaller payoff because it is a smaller loss. Short sales are also common for somebody facing foreclosure for the same reason-the bank is taking the lesser of two evils. If a $300,000 house goes into auction, it may sell for $170,000 or $200,000, but if the homeowner sells it, it will go for much higher, and the bank will save thousands in principal and legal fees.

Payment or rate reduction One last type is payment reduction or rate reduction. Again, if somebody is struggling, but the lender believes they could stay current with a lower rate or smaller payment, they might agree to it because it is the lesser of two evils. They are making less on the loan, but it beats foreclosure. If somebody is making less income now, the bank may agree to lower the payments to help the homeowner stay current. Another way to lower the payment is to stretch out the note for 40 or 50 years. Many banks will do this in lieu of lowering the interest rate because then they can lower the payments to help the homeowner and still make the same interest. In a settlement with the State of Illinois, mortgage giant Countrywide had to re-cast all of its stated loans that their retail branches originated to do the new payments on full documentation, and give homeowners payments they could actually afford. There were people who got 2 or 3% over 40 or 50 years because of this.

Notice the one big catch in all the modifications (where people stay in their homes) - the homeowners have to be working. Whether they were out of a job temporarily or are just making less now they all require current employment. That is a big catch for many folks with the rising unemployment rates. The only one available for those currently unemployed is for a short sale. Yes it is not a foreclosure, and hopefully the homeowner will not feel the same credit pain with their short sale as with a foreclosure. But lenders are becoming more and more willing to do short sales. Perhaps we will see those numbers rising to something substantial.

Meanwhile, we have RealtyTrac that lets us know foreclosure numbers, but is anyone gathering any short sales data? Not that we know of yet...