Customers of Wells Fargo Bank and Bank of America filed two separate lawsuits in a U.S. district court alleging that the mortgage lenders were not honoring promises to grant permanent home loan modifications. The borrowers claim they were given trial modifications and that, while they made their modified payments as agreed, permanent mortgage modifications were not granted. They assert that the banks were obligated to make the loan mods permanent once the trial period concluded. Are they right? Here's a look behind the scenes of your mortgage modification.
The mortgage modification process is loaded with misunderstanding. While the questionnaire on the government's Making Home Affordable (MHA) website is very straightforward -- answer a few questions and you'll know if you're eligible for a modification -- it doesn't tell the whole story. "Eligible" isn't the same as "qualified."
Who Gets a Trial Modification?
Trial modifications are granted to homeowners who meet minimum eligibility criteria:
- The borrower is in default or at imminent risk of foreclosure;
- The property is a primary residence;
- The loan balance does not exceed $729,750 (for a 1-unit home); and
- The mortgage was originated before January 1, 2009.
Once you have been granted a trial loan modification, in most states, any foreclosure action must be suspended until your Home Affordable Modification Program (HAMP) qualification has been determined.
Who Gets a Permanent Modification?
Contrary to the claims of the plaintiffs' attorneys in the two above-mentioned cases, being granted a trial modification does not mean you qualify for a permanent one. Here is what the official HAMP Trial Modification Agreement says:
Congratulations! You are approved to enter into a trial period plan under the Home Affordable Modification Program. This is the first step toward qualifying for more affordable mortgage payments.
As it says, trial modifications are only the first step in a long and involved process. The letter goes on to list the documents that need to be provided and when they must be received to complete step two. Borrowers who do not turn in all required documents or who do not make their trial payments by the specified due dates are deemed ineligible for HAMP. Required documents can include:
- MHA Request for Modification and Affidavit or MHA Hardship Affidavit;
- IRS form 4506-T (this allows the lender to get a transcript of your tax returns);
- Two recent pay stubs showing year-to-date income for each employed borrower;
- Quarterly profit and loss statement for each self-employed borrower;
- Benefits statement for pension income;
- Divorce decree/separation agreement if applicable;
- Two recent bank statements (all accounts, all pages); or
- Two years of tax returns.
Qualifying for a HAMP Modification
Step three is called the waterfall test. The lender conducts this test to see if it is possible to modify your loan (under the HAMP guidelines) to get your monthly payment down to 31% of your gross income. Under the guidelines, lenders first must lower your interest rate to as low as 2% if necessary. If the resulting principal, interest, taxes, insurance and HOA dues combined is still above 31% of your gross monthly income, they can then extend the term of your mortgage -- a month at a time -- to as long as 40 years. Finally, if your monthly payment is still higher than 31% of your gross income, they may forbear your principal balance -- but the balance can't be dropped to less than the value of your property, and that amount must be repaid when you sell the home.
Here's an example:
- Your monthly income is $4,000.
- You owe $350,000 on a home worth $325,000, and your current monthly payment is $2,248 plus $250 a month for taxes and insurance.
- Your payment must drop to 31% of your income, or $1,240 a month. Your taxes and insurance can't be changed, so your mortgage payment will have be $990 a month.
Can this $990 payment be done under HAMP? We can use HSH.com's mortgage amortization calculator to determine monthly payments on the $350,000 with various loan modifications:
- A 2% interest rate gets the monthly payment down to $1,294.
- That 2% rate over a 40-year term makes the monthly payment $1,060.
- Forbearing principal of $23,100 finally yields a payment of $990 and a balance of $326,900, which is higher than the property's value. The borrower passes the waterfall test.
Finally, your data is input into a program designed to estimate the cash flow the lender is likely to derive from modifying your loan and compare it to what the lender would most likely earn if it does not modify your loan. This is step four and it's called a Net Present Value (NPV) test. HAMP administration says:
Each loan has a probability of default and cure in both the no-modification and modification scenarios. The default model of the base NPV model predicts four probabilities of default and cure:
- Probability of cure for a loan that is not modified.
- Probability of default for a loan that is not modified.
- Probability of cure for a modified loan.
- Probability of default for a modified loan.
A lot goes into this analysis, including credit scores, property value, income and an interest rate used to discount future cash flows and value your loan in today's dollars. They look at the likelihood of default or re-default, what the property would fetch in a foreclosure sale and the cost of reducing the payment to 31% of your gross monthly income. The result of the NPV test is either positive (meaning the lender is better off modifying your loan) or negative (meaning the lender is better off not modifying your loan, or perhaps even foreclosing). If the result is negative, the lender is not required to offer you a permanent modification.
It's pretty obvious from studying all this that a trial modification hardly amounts to the promise that the plaintiffs say it is. And know that the more documentation you provide, the better your credit rating and the fewer concessions your lender has to make, the better your chance of getting a permanent loan modification.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.