What is Loan Modification?
Definitions:
Loan Modification: A transaction in which lender agrees to modify any or some of the terms of the mortgage. This is a process where an existing note is modified, but not cancelled. Changes may include: extending the term of the loan, changing the monthly payments, changing the interest rate, etc. Loan Modification known as Loss Mitigation and Mortgage Mitigation is a process that helps homeowners’ get their first mortgage, second and third mortgages negotiated to terms with lower monthly payments.
Loan modification (or mortgage modification) describes the process where the terms of a mortgage are modified outside the original terms of the contract agreed to by the lender and borrower (i.e mortgagor and mortgagee). In general, any loan can be modified. This article is about real estate mortgages.
Background
In the normal progression of a mortgage, payments of interest and principal are made until the mortgage is paid in full (or paid-off). Typically, until the mortgage is paid, the lender holds a lien the property and if the borrower sells the property before the mortgage is paid-off, the unpaid balance of the mortgage is remitted to the lender to release the lien. Generally speaking, any change to the mortgage terms is a modification, but as the term is used it refers a change in terms based upon either the specific inability of the borrower to remain current on payments as stated in the mortgage[1], or more generally government mandate to lenders.
Types of Modifications
Mortgages are modified to the benefit of the borrower in one or more of the following ways:
- Reduction in interest rate, or a change from a floating to a fixed rate, or in how the floating rate is computed
- Reduction in principal
- Reduction in late fees or other penalties
- Lengthening of the loan term
- Capping the monthly payment to a percentage of household income
The programs available will vary accordingly.
There may be modifications made at the discretion of the lender. The lender is motivated to offer better terms to the borrower because of the expectation that the borrower might be able to afford a lower payment, and that a performing loan (i.e. one in which payments are current) will be more valuable ultimately than the proceeds obtained from a foreclosure sale.
The state and federal government may structure a mortgage modification program as voluntary on the part of the lender, but may provide incentives for the lender to participate. A mandatory mortgage modification program requires the lender to modify mortgages meeting the criteria with respect to the borrower, the property, and the loan payment history.
United States 1930's
During the Great Depression in the United States a number of mortgage modification programs were enacted by the states to limit the economic disruption of foreclosure sales and subsequent homelessness. Because of the shrinkage of the economy many borrowers lost their jobs and income and were unable to maintain their mortgage payments. These programs were upheld by the supreme court and a new method to bring relief to homeowners was born. These little known facts have been available but seldom used till the new crisis through 2006-2009 and beyond.
United States 2000's
The research shows the FDIC since 1980 has been using this method to reduce troubled loans of failing banks again not much coverage or news on these loan modifications.
The U.S. housing boom of the first half of this decade ended abruptly in 2006. Housing starts, which peaked at more than 2 million units in 2005, have plummeted to just over half that level, with no recovery in sight. Home prices, which were increasing at double-digit rates nationally in 2004 and 2005, are now falling in many areas across the country As home prices decline, the number of problem mortgages, particularly in sub-prime and Alt-A portfolios, is rising. As of third quarter 2007, the percentage of sub-prime adjustable-rate mortgages (ARMs) that were seriously delinquent or in foreclosure reached 15.6 percent, more than double the level of a year ago The deterioration in credit performance began in the industrial Midwest, where economic conditions have been the weakest, but has now spread to the former boom markets of Florida, California, and other coastal states.
During 2007, investors and ratings agencies have repeatedly downgraded assumptions about sub-prime credit performance. A Merrill Lynch study published in July estimated that if U.S. home prices fell only 5 percent, subprime credit losses to investors would total just under $150 billion, and Alt-A credit losses would total $25 billion. On the heels of this report came news that the S&P/ Composite Home Price Index for 10 large U.S. cities had fallen in August to a level that was already 5 percent lower than a year ago, with the likelihood of a similar decline over the coming year.
The complexity of many mortgage-backed securitization structures has heightened the overall risk aversion of investors, resulting in what has become a broader illiquidity in global credit markets. These disruptions have led to a precipitous decline in sub-prime lending, a significant reduction in the availability of loans, and higher interest rates on jumbo loans. The tightening in mortgage credit has placed further downward pressure on home sales and home prices, a situation that now could derail the U.S. economic expansion.
More Homes in Danger of Foreclosure
Residential mortgage credit quality continues to weaken, with both delinquencies and charge-offs on the rise at FDIC-insured institutions. This trend, in tandem with upward pricing of hybrid adjustable-rate mortgage (ARM) loans, falling home prices, and fewer refinancing options, underscores the urgency of finding a workable solution to current problems in the sub-prime mortgage market. Legislators, regulators, bankers, mortgage servicers, and consumer groups have been debating the merits of strategies that may help preserve home ownership, minimize foreclosures, and restore some stability to local housing markets.
The Banking Industry Attempt at Averting Foreclosures
On December 6, 2007, an industry-led plan was announced to help avert foreclosure for certain sub-prime homeowners who face unaffordable payments when their interest rates reset. This plan provides for a streamlined process to extend the starter rates on sub-prime ARMs for at least five years in cases where borrowers remain current on their loans but cannot refinance or afford the higher payments after reset. An important component of the industry-led plan is detailed reporting of loan modification activity.
Loan Modification Companies
Loan modification companies assess borrowers’ ability to pay through analysis of wage statements, investment accounts, bank accounts and tax returns, among other data. They then make proposals to the lending institutions for restructuring of mortgage terms in a fashion that will enhance the likelihood of repayment.
Loan modification companies can be engaged by borrowers to negotiate on their behalf. They also can be hired by lenders to help salvage troubled loans. A given loan modification company may rely primarily on one or the other sources of clients, or both.
Lenders have an interest in offering concessions to troubled borrowers because the costs of foreclosure are high. Among other things, borrowers do not want to take possession of illiquid real estate, especially in falling markets.
Billing
Loan modification companies’ fees may be billed either to the borrower or to the lender. If the company is engaged by the borrower, the borrower may be assessed the fee, sometimes up front and without guarantees of results. In other cases, even if the borrower engages the company’s services, the lender may be charged the fee, in the case of a successful renegotiation.
Results
If the request for a loan modification is rejected, you may want to try it again in a couple months. Some lenders do not document the loan modification attempt you make. They are often motivated by changes in the housing market and their intent changes as more and more loans go into default. It does not hurt to try again. It is smart to work with a loan modification specialist, a seasoned loan officer or an attorney who specializes in real estate, mortgage lending and loan modifications. They understand how to speak to loss mitigation department, personnel and can get a general idea of the mood and trends of your lenders loss mitigation department.
A loan adjustment that is required by a Relief Act or a decision or order of a court is not subject to any limitations on modification provided and may be entered into without regard to whether the Mortgage Loan is in payment default.