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Saturday, January 10, 2009

Some Context on the Process of Loan Modifications

Because the process of loan modifications, the process by which banks re negotiate terms of loans for borrowers that can't afford their current ones, is so new and unregulated, there isn't necessarily one process. In fact, depending on the company a particular borrower is working with, the process is in many cases quite unique. Still, this is the process that I have found to be most common.

First, for a loan modification process to start the borrower will have to be behind on their mortgage. Once a borrower falls behind, they are first directed to the collections department of the bank. The collections department is the initial department that attempts to collect on any past due mortgage balance.

Yet, the department that a loan modification specialist wants to talk to is loss mitigation.

Loss mitigation [1]is used to describe a third party helping a homeowner, a division within a bank that mitigates the loss of the bank, or a firm that handles the process of negotiation between a homeowner and the homeowner's lender. Loss mitigation
works to negotiate mortgage terms for the homeowner that will prevent foreclosure.

Yet, loss mitigation often doesn't get involved until a borrower is at least 60 days behind. Think about what that means. If you are borrower and you are only one month late, then you don't qualify YET for a loan modification. Now, if you were to fall another month behind then you are likely more eligible for a loan modification. Frankly if that doesn't work, you need to fall even farther behind.

Now, once the loan goes to the loss mitigation department then that department begins the long process of modifying a loan with the person representing the borrower. This process can take anywhere between 60 and 90 extra days. Now as soon as a loan modification company steps in, they usually negotiate with the bank to stop all payments while the process is continuing. This means that borrowers often don't make a payment for up to six months. Then, after the process is over they are "rewarded" with a new loan in which the terms are much better than the ones they were currently in.

So, what do we have? We have a process in which a borrower isn't merely encouraged to fall behind on their mortgage but frankly is often required to fall at least two months behind. Then, as soon as the process starts, the borrower is immediately removed from the responsibility of making any more mortgage payments. Then, after this process is over this same borrower is rewarded with a loan that is better than the one they couldn't pay back. Now, what do you think will happen once the process of loan modifications becomes well known to all borrowers currently struggling with their loans?

That's exactly what will happen because the FDIC is already guaranteeing millions of loan modifications. In California, a borrower can't be foreclosed on before the loan is modified. Furthermore, Barack Obama has made his intention known that he will do everything he can to avoid foreclosures. As such, we will soon see all those struggling to make their payments and certainly those just a bit behind on their mortgage begin to fall farther behind because the process of loan modifications not only encourages such actions BUT IT REQUIRES IT.


DS said...

I understand this is a moral hazard against Conservative ideology. But the alternative is neighborhoods full of for sale signs, and no turnover in the housing market because everyone's waiting for it to bottom. This way, the market can bottom in an organized way.

Looked at from another angle, this is simply extending the adjustable rate mortgage, which banks embraced, from the rate to the principle.

mike volpe said...

No, the alternative is to allow the market to take its course.

What folks like you claim is that mass foreclosures is the worst case scenario and must be avoided at all costs. I disagree. I think that rewarding bad behavior is much worse. I would much rather have a street full of for sale homes for months or years, than to continue encouraging the exact same behavior that got us here.

Anonymous said...

I think the problem is worse than portrayed by both sides. I am totally against rewarding failure and punishing success, the liberal mantra. But what is being done is to postpone today's losses off to 30 years from now. And while doing this, transfer wealth from repsonsible home owners to irresponsable ones.

Suppose we have two homeowners that bought houses for $120K and because of market conditions, those values have fallen to 80K. Luckily the market stabilizes for the next 30 yrs and housing prices increase at a modest 5% a year. At the end of that time, the houses (providing they are kept up the same) are worth $357,419.55.

Mr. R (for Responsible) put 20K down and is financing 100K @ 10%.

Mr. I (for Irresponsible) put no money down and financed 120K @ 10%.

Mr. R will have a monthly payment of $877.57 and pay of the loan in 30 yrs to the tune of $315,925.77. That means, were he to sell, that he would net $21,493.78 after subtracting his loan payments and down payment.

Had Mr I continued with the $1,053.09 monthly payment, he would have paid $379,110.92 in loan payments and had a net loss of ($21,691.37).

But Mr. I. gets into trouble and renegotiates his loan by getting the courts to modify his principle to 80K (the house's present worth) and rate to 8%. The result is that his payment is dropped to a managable $587.01 and paying $211,324.20 for his new loan. The net profit for Mr. I at the end of 30 years is $146,095.35.

Does that seem fair?

maxibomero said...

My friend worked with maximondo modificataion consultant corp. of chicago, il 60618 7735888776 and told me that the best procedure for loan modification are: the government should enforced mandatory total modification for the lenders considering the personal expeses such as groceries,utilities,gasoline and car and house maintenance,insurance also. The government should also enforced the lenders to do approval action within 30 days and the foreclosure proceeding should start after 8th missed payment. The government should instructed the lenders to pay the private loan modification companies.