Loan modification in the United States

Loan modification is a process whereby a homeowner's mortgage is modified and both lender and homeowner are bound by the new terms. The most common modifications are lowering the interest rate, reducing the principal balance, 'fixing' adjustable interest rates, increasing the loan term, forgiveness of payment defaults & fees, or any combination of these.

History

According to the FDIC chairman, Sheila C. Bair, looking back as far as the 1980s, "the FDIC applied workout procedures for troubled loans out of bank failures, modifying loans to make them affordable and to turn nonperforming into performing loans."

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 (see Chart 1). 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 (see Chart 2). 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.

Chart 1

Chart 2

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/Case-Shiller 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 Alt-A loans, and higher interest rates on jumbo loans (see Chart 3). 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.

Chart 3

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|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.

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. Working with the Treasury Department and other bank regulators, the FDIC will monitor loan modification levels and seek adjustments to the protocols if warranted.

Purpose

Sheila Bair has “long advocated a systematic and streamlined approach to loan modification that puts borrowers into long-term, sustainable mortgages. I support the industry plan as a means to allow borrowers to remain in their homes, provide investors with higher returns than can be obtained under foreclosure, and strengthen local neighborhoods where foreclosures are already driving down property values. It is my hope that this plan will be implemented in a way that delivers real progress on these important policy goals.”

Under the financial rescue package, the Treasury plans to directly inject $250 billion of capital into U.S. banks in exchange for preferred shares. Nine of the largest U.S. banks were essentially arm-twisted into signing on for the first $125 billion in capital infusions. "Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity ... are in a state of shocked disbelief," said the former Fed chief. "Specifically, the government could establish standards for loan modifications and provide guarantees for loans meeting those standards," Bair said. "By doing so, unaffordable loans could be converted into loans that are sustainable over the long term."Bair made clear that she considers existing voluntary loan modification programs inadequate. "We are falling badly behind and more needs to be done," she said on a day when RealtyTrac announced U.S. home foreclosure filings in the third quarter 2008 were 71% above the comparable period a year earlier.

Streamlined modification process

The adoption of this streamlined modification framework is an additional tool that servicers will now have to help avoid preventable foreclosures. This framework will not only help homeowners who receive a streamlined modification, but will also further address servicer capacity concerns by freeing up resources, helping ensure that borrowers do not fall through the cracks because servicers aren't able to get to them.

This is the first time the industry has agreed on an industry standard. The benchmark ratio for calculating the affordable payment is 38 percent of monthly gross household income. Once the affordable payment is determined, there are several steps the servicer can take to create that payment – extending the term, reducing the interest rate, and forbearing interest. In the event that the affordable payment is still beyond the borrower’s means, the borrower’s situation will be reviewed on a case-by-case basis using a cash flow budget. This program resulted from a unified effort among the Enterprises, Hope Now and its 27 servicer partners, Treasury, the Federal Housing Administration (FHA) and FHFA. In addition, we’ve drawn on the FDIC’s experience and assistance from developing the IndyMac streamlined approach and have greatly benefited from the FDIC’s input and example. To accommodate the need for more flexibility among a larger number of servicers, the Streamlined Modification Program does differ from the IndyMac model in a few areas. However, it uses the same fundamental tools to achieve the same affordability target.

The Streamlined Modification Program (SMP) was developed in collaboration with the Federal Housing Finance Agency (FHFA), the Department of Treasury, Freddie Mac, and members of the HOPE NOW Alliance.

SMP Eligibility Criteria Include

1. Conforming conventional or jumbo conforming mortgage loans originated on or before January 1, 2008;
2. At least three payments past due;
3. The loan must be secured by a one-unit property that is the borrower's primary residence;
4. Current mark-to-market LTV of 90 percent or more; and
5. Property cannot be abandoned, vacant, condemned, or in a serious state of disrepair.
6. SMP is designed to reduce distressed borrowers' monthly mortgage payments to an amount equal to 38 percent of their monthly gross income. To do so, servicers may, in the following order:
7. Capitalize accrued interest, escrow advances and costs,if allowed by state law;
8. Extend the term of the mortgage loan by up to 480 months;
9. Reduce the mortgage loan interest rate in increments of .125% to a fixed rate that is not less than 3% (if this exercise results in a below market rate, it will, after 5 years, step up in annual increments to a market rate);
10. As a last resort, provide for principal forbearance, which will result in a balloon payment fully due and payable upon borrower's sale of the property or payoff or maturity of the loan.

Borrowers meeting the SMP eligibility requirements enter into a trial period in which they must make monthly loan payments equal to the proposed modified payment. Timely payments must be made for three consecutive months before a borrower's loan can be modified under the SMP.

The "Streamlined Modification Plan," or SMP, which is an expansion of what many

lenders are already doing, will be implemented by December 15, 2008.

IndyMAC Plan

With the Bush administration refusing to enact FDIC Chairwoman Sheila Bair's controversial loan modification plan, lawmakers are taking matters into their own hands.

• Offer proactive workout solutions designed to address borrowers who have the willingness but limited capacity to pay.

1. Return the loan to a current status.
2. Capitalize delinquent interest and escrow.
3. Modify the loan terms based on waterfalls, starting at a front-end 38 percent HTI ratio down to a 31 percent HTI ratio subject to a formal NPV floor.
4. Reduce interest rate to as low as 3 percent.
5. Extend, if necessary, the amortization and/or term of the loan to 40 years.
6. Forbear principal if necessary.

• Provide borrowers the opportunity to stay in their home while making an affordable payment for the life of the loan.

1. Require the borrower to make one payment at the time of the modification.
2. Cap the interest rate at the Freddie Mac Weekly Survey rate effective as required to meet the target HTI ratio, fixing the adjusted rate and monthly payment amount for 5 years.
3. Step up the initial interest rate gradually starting in year 6 by increasing it one percentage point each year until reaching the Freddie Mac Weekly Survey rate cap.

• Use a financial model with supportable assumptions to ensure investor interests are protected.

1. Input borrower specific income information into the NPV Tool, which provides a real-time workout solution.
2. Perform automated loan level underwriting across large segments of the portfolio to support pre-approved bulk mailings.
3. Verify income information the borrower provided via check stubs, tax returns, and/or bank statements.
4. Compare the cost of foreclosure to mitigate losses.
5. Mandate that the cost of the modification must be less than the estimated foreclosure loss.

• Borrower eligibility

1. The loan is at least 60 days delinquent where the loan is considered one day delinquent on the day following the next payment due date. Many servicing contracts often contain a standard clause allowing the servicer to modify seriously delinquent or defaulted mortgages, or mortgages where default is “reasonably foreseeable”.
2. Foreclosure sale is not imminent and the borrower is currently not in bankruptcy, or has not been discharged from Chapter 7 bankruptcy since the loan was originated.
3. The loan was not originated as a second home or an investment property.

We (IndyMac Bank) commend FDIC Chairman Sheila Bair for her leadership in developing a systematic loan modification protocol. FHFA, the GSEs and HOPE NOW relied heavily on the IndyMac model in developing this new protocol.[

Fannie Mae / Freddie Mac Plan

In the task at hand to make headway against foreclosures and the depressed housing market. Fannie Mae and Freddie Mac entered a new phase on December 9, 2008 for a fast-track program meant to make "hundreds of thousands of mortgages affordable to people who can't currently meet their monthly payments."

Through the SMP, servicers may change the terms of a loan to reduce a borrower's first lien monthly mortgage payment, including taxes, insurance and homeowners association payments, to an amount equal to 38 percent of gross monthly income. The changes in terms may include one or more of the following:

1. Adding the accrued interest, escrow advances and costs to the principal balance of the loan, if allowed by state law;
2. Extending the length of the mortgage loan as appropriate;
3. Reducing the mortgage loan interest rate in increments of 0.125 percent to an interest rate that is not less than 3 percent. If the new rate is set below the market interest rate, after five years it will step up in annual increments to either the original loan interest rate or the market interest rate at the time of the modification,whichever is lower;
4. Forbearing on a portion of the principal, which will require the borrower to make a balloon payment when the loan matures, is paid off, or is refinanced.

Eligibility Requirements

1. Conforming conventional and jumbo conforming mortgage loans originated on or before January 1, 2008;
2. Borrowers who are at least three or more payments past due and are not currently in bankruptcy;
3. Only one-unit, owner-occupied, primary residences; and
4. Current mark-to-market loan-to-value ratio of 90 percent or more.

New Servicer Guidance

Fannie Mae's foreclosure prevention efforts have generally been made available to a borrower only after a delinquency occurs. Under Fannie Mae's new guidance, loan servicers can use foreclosure prevention tools to assist distressed borrowers when a borrower demonstrates the need. As noted above, these guidelines apply to borrowers who are still current in their payments, but whose default is reasonably foreseeable. This new guideline is effective immediately.

Hope for Homeowners Plan (HUD) / FHA)

The H4H Program is effective for endorsements on or after October 1, 2008, through September 30, 2011.

• Affordability versus value: lenders will take a loss on the difference between the existing obligations and the new loan, which is set at 96.5 percent of current appraised value. The lender may choose to provide homeowners with an affordable monthly mortgage payment through a loan modification rather than accepting the losses associated with declining property values.
• Borrower eligibility: Lenders that determine the H4H program is a feasible and effective option for mitigating losses will assess the homeowner’s eligibility for the program:

1. The existing mortgage was originated on or before January 1, 2008;
2. Existing mortgage payment(s) as of March 1, 2008 exceeds 31 percent of the borrowers gross monthly income for fixed-rate mortgages; For ARMs, the existing mortgage payment(s) exceeds 31 percent of the borrowers gross monthly income as of March 1, 2008 OR the date of the new loan application.
3. The homeowner did not intentionally default, does not have an ownership interest in other residential real estate and has not been convicted of fraud in the last 10 years under Federal and state law; and
4. The homeowner did not provide materially false information (e.g., lied about income) to obtain the mortgage that is being refinanced into the H4H mortgage.

Original Cost of Program

1. 3 percent upfront mortgage insurance premium and a 1.5 percent annual premium,
2. Equity and appreciation sharing with the Federal government ,and
3. Prohibition against new junior liens against the property unless they are directly related to property maintenance.

• Please also view the HUDS fact sheet (PDF) for full details

Updated Hope for Homeowners Improvements

1. Eliminates 3% upfront premium
2. Reduces 1.5% annual premium to a range between .55% and .75%, based on risk-based pricing (also makes technical fix to permit discontinuation of fees when loan balance drops below certain levels, consistent with normal FHA policy)
3. Raises maximum loan to value (LTV) from 90% to 93% for borrowers above a 31% mortgage debt to income (DTI) ratio or above a 43% ratio
4. Eliminates government profit sharing of appreciation over market value of home at time of refi. Retains government declining share (from 100% to 50% after five years) of equity created by the refi, to be paid at time of sale or refi as an exit fee
5. Authorizes payments to servicers participating in successful refis
6. Administrative simplification: (a) eliminates borrower certifications regarding not intentionally defaulting on any debt, (b) eliminates special requirement to collect 2 years of tax returns, (c) eliminates originator liability for first payment default, (d) eliminates March 1, 2008 31% DTI test, (e) eliminates prohibition against taking out future second loans, (f) requires Board to make documents, forms, and procedures conform to those under normal FHA loans to the maximum extent possible consistent with statutory requirements.

Troubled Assets Relief Program (TARP)

The systematic foreclosure prevention and mortgage modification program under this section shall be a program established by the Secretary, in consultation with the Chairperson of the Board of Directors of the Federal Deposit Insurance Corporation and the Secretary of Housing and Urban Development, that—

1. Provides lenders and loan servicers with certain compensation to cover administrative costs for each loan modified according to the required standards; and
2. Provides loss sharing or guarantees for certain losses incurred if a modified loan should subsequently re-default.

Commitment of Resources

The comprehensive plan established pursuant to subsection (a) shall require the commitment of funds made available to the Secretary under title I of the Emergency Economic Stabilization Act of 2008 in an amount up to $100,000,000,000 but in no case less than $40,000,000,000.

In a press conference Tuesday, Federal Housing Finance Agency director James Lockhart said the program would target high-risk borrowers — those 90 or more days delinquent on their mortgages — and employ various modification strategies to get borrowers down to an “affordable” mortgage payment, defined as 38 percent of a household’s monthly gross income on a first mortgage payment.

How to Get a Loan Modification

1. Call your lender
2. Call Hope Now Hotline
3. Go through an attorney based loan modification specialist

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 in this Subsection 5.3(4)(Please Review link provided)and may be entered into without regard to whether the Mortgage Loan is in payment default.

External links

• http://www.freddiemac.com/sell/guide/bulletins/pdf/bll121208.pdf
• http://www.freddiemac.com/sell/factsheets/streamrefi.htm
• http://www.fdic.gov/news/news/speeches/archives/2008/chairman/spdec1708.html
• http://in.reuters.com/article/privateEquity/idINN0948652720090109
• http://www.houseloanmodifications.com