The Federal mortgage modification process is poorly understood, and there seems to be a lot of unwritten rules about who gets approved and who doesn't. It's essential to learn the truth about mortgage modification and how to to approved for one.
Myth #1: You Have to Be in Default on Your Mortgage to Qualify for Help
That is absolutely not true. According to the U.S. Treasury Department, mortgage lenders are getting incentives to modify loans while they are still current: "One-time bonus incentive payments of $1,500 to lender/investors and $500 to servicers will be provided for modifications made while a borrower is still current on mortgage payments."
However, deliberately falling behind on your mortgage payments can easily backfire for two reasons.
First, if you don't qualify for a modification, you've put some serious dings in your credit score for nothing, and second, if you go more than 60 days past due, your lender has to run your modification through a net present value (NPV) test. What does this mean? Per Treasury guidelines: "A standard NPV Test will be required on each loan that is in Imminent Default or is at least 60 days delinquent under the MBA delinquency calculation. This NPV Test will compare the net present value (NPV) of cash flows expected from a modification to the net present value of cash flows expected in the absence of modification. If the NPV of the modification scenario is greater, the NPV result is deemed positive." In other words, if the lender would lose less by foreclosing than by modifying your loan, you don't qualify for a modification. That's a very good reason not to let your mortgage go into default.
Myth #2: You Can't Get a Loan Modification if You File for Bankruptcy Protection
This myth probably came from the failure of recent mortgage cram-down legislation. That is, some members of Congress wanted to give bankruptcy judges the power to reduce your mortgage principal in bankruptcy proceedings, but that provision was killed. However, you can get a mortgage modification while going through bankruptcy. Here's the official statement from Treasury: "Borrowers in bankruptcy are not automatically eliminated from consideration for a modification." In some circumstances, a bankruptcy can help your case -- if you discharge debts that make paying your mortgage too difficult, mortgage lenders might feel that any loan mod they grant you is more likely to stick after bankruptcy. In addition, any arrearages you owe become part of the bankruptcy filing, and lenders would also be unable to collect a deficiency if they were to foreclose. This puts you in a stronger position, and many lenders are fully open to negotiating a modification during a bankruptcy to minimize their own losses.
Myth #3: You Can't Get a Loan Modification if You Are Unemployed
If you are receiving unemployment benefits, the lender can factor them in when determining your income and your ability to make a modified mortgage payment. Per the Treasury Department, "The borrower's Monthly Gross Income...includes wages and salaries, overtime pay, commissions, fees, tips, bonuses, housing allowances, other compensation for personal services, Social Security payments, insurance polices, retirement funds, pensions, disability or death benefits, unemployment benefits, rental income and other income." In addition, the Home Affordable Modification Program (HAMP) guidelines state that, "If the borrower receives public assistance or collects unemployment: Acceptable documentation includes letters, exhibits or a benefits statement from the provider that states the amount, frequency, and duration of the benefit. The servicer must determine that the income will continue for at least nine months."
Myth #4: Federal Law Requires Mortgage Lenders to Modify Mortgages
The fact is, HAMP is a voluntary program. Only lenders who received TARP Money are obliged to help you. However, if your mortgage meets HAMP guidelines, and your lender carefully documents that it does (hence all those requests for paperwork), it gets incentive payments. For example, if your mortgage payment takes up 45% of your gross income, your loan should be modified (if possible) to bring down the payment to 31% of your gross monthly income. Your lender eats whatever interest rate reduction is required to get that ratio to 38%, then the government pays your lender the rest to reduce your payment to 31%. Your lender, if it chooses to modify your loan, is willing to do so because you are more likely to continue making payments if the new loan amount is more manageable for you. In addition, loan servicers get a $1,000 payment upfront for modifying your mortgage plus up to $1,000 per year for every year you remain in the program (to a max of three years). If your mortgage meets HAMP guidelines but you have sufficient assets to make your monthly payments, your lender is unlikely to modify your mortgage and may choose to foreclose.
Myth #5: Modification Companies Can Get Your Principal Balance Reduced
That's extremely unlikely, although companies everywhere are trumpeting promises of huge principal writedowns in order to get you to sign up with them (and pay them upfront as well). The fact is, very few loan modifications involve principal reductions. Mortgage lenders aren't compensated by the government for writing down mortgage balances, making them extremely reluctant to do so.
Modifications with principal reductions make up only 3.1% of all mods. According to the Office of Thrift Supervision, principal reductions are usually done when a borrower has both a first and second mortgage, and the second is negotiated down and settled for $0.10 or $0.20 on the dollar.
There are many scammers that claim they get your loan balance written down, but that's simply not true. If lenders started regularly reducing mortgage balances, every underwater borrower, and some who aren't, would demand the same treatment. This practice could crush the lending industry, and the flood of litigation from investors who are losing huge sums of money could take down Wall Street too.
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.
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