Introduction: First for all those unfamiliar with loan modifications...Loan modification is the process by which a bank renegotiates the terms of a loan with a borrower that is having difficulty making their current payment. As such, if a borrower is behind on their mortgage, or on time but struggling, loan modifications will allow those same borrowers to see their terms imporve. This was always meant to be a limited process decided on a case by case basis. Yet, with the mortgage crisis in full swing, it appears that loan modifications will soon be a part of everyday mortgage business.
When I read this piece by Dick Morris, I was actually surprised. The piece analyzes how and why President Obama's plan to modify loans to save millions of borrowers from foreclosure has failed. The reason that I am surprised is because I have two former colleagues that have actually found great financial success in modifying loans. For them at least, President Obama's loan modification plan has been a great boon. So, I spoke with one about the article and in the course of the conversation I was able to guage why the president's loan modification plan has failed.
In fact, one of the reasons that the program is floundering is the confusion surrounding the program. The president announced his loan modification program with great fanfare but he has done little to educate the public about how to go about securing a loan and figuring out if you qualify. In fact, following the announcement, he has said little about the program. This leaves a brand new industry and millions of naive borrowers to try and figure it out for themselves.
What I've been told is that the loan modification process is terribly sophisticated, time consuming and frustrating and as such most finally fail at it. In fact, the reason these two have succeeded so well is because they have the sort of sophistication that most mortgage professionals lack.
For the most part, trying to do a loan modification on your own is nearly impossible. It requires faxing all sorts of documents, staying in contact with the bank, often an hour at a time, and following up day after day for weeks and months. Unless borrowers are themselves unemployed, they simply will not have the time to do it themselves. So, they need to find someone to represent them. Since loan modifications on a mass scale is a brand new idea, so to are companies that specialize in loan modifications.
In fact, it's almost exclusive former mortgage brokers that see an opportunity to make money in a new industry. In fact, for almost a year before the announcement, loan modification companies were popping up as these became more popular. Well, you can well imagine how well loan modifications will go on a mass scale when they are being procured almost entirely by people that have been doing them less than a year.
Second, most of these loan modifiers, though not my two former colleagues, are many of the same unscrupulous mortgage brokers that specialized in sub prime loans that got us into all of this. Most of them aren't in loan modifications because the see an opportunity to help desperate people but to make a lot of money. So, most charge fees up front, and often only make part of the fees refundable. In the meantime, they are often just as naive about how loan modifications work as they were about how loans worked. So, while they charge as much as $2500 for their services, their services aren't worth more than $5. So, often an incompetent modifier gets a modification denied.
There is also a lot of confusion about who qualifies for what. My former colleague told me that ultimately the decision is left to the bank. The Obama administration has created guidelines, put pressure, and even offered financial incentives, to modify loans that fit certain guidelines, but banks are ultimately in a position to decide. Banks continue to be reluctant to approve loan modification because they, like me, understand that there is a great moral hazard to giving someone a better deal simply because their current deal is more than they can afford. As such, to get a loan modification approved it requires someone with enough sophistication that they present a strong enough case so that it overcomes the bank's natural reluctance to deny them and create this moral hazard. So, here again, how many loan modifiers are there that understand how to present the case in a way that the bank will see benefit from their perspective that overcomes the risk?
As such, it takes a sophisticated and dedicated loan modifier to put together a loan modification that the bank will approve. For instance, every loan modification requires a budget. Within that budget, the Treasury department has created guidelines for allowances for each and every expense: phone, food, clothes, etc. So, sophisticated modifiers will max out the allowances because that will present the borrower in the most financially desperate situation possible. (remember loan modifications work in reverse of a loan. You want to present as weak a case as possible) At the same time, these modifications have other guidelines. For instance, the Treasury wants the debt to income for all real estate expenses to be 31%. At the same time, they want the rate to be no less than 2% on a forty year loan. So, sometimes, a modifier could present a case that's too desperate and it will be rejected. At the same time, often banks will accept rental income proven only by a lease and cash income proven by nothing to get a borrower qualified. A sophisticated modifier would know all this and present a modification in the right way to get approved.
If banks follow the Treasury guidelines, they receive financial benefits. For instance, they receive $1000 for each loan they modify under the guidelines. They also receive a monthly stipend of the difference in payment between a 38% debt to income mortgage payment and a 31% debt to income mortgage payment. As such, it would make sense for most modifiers to understand the guidelines and conform them to specifications of the Treasury. There's the rub. How many understand them and how many can conform them consistently on each modification?
Ultimately, loan modifications suffer from what all brand new industries suffer from. In the beginning, people make tons of mistakes and learn from them until the industry grows. Here, though, loan modifications are different from most industries. We don't have time for loan modifications to go through the normal business cycle that say cell phones went through. By the time everyone figures everything out, millions of folks will get foreclosed on. Instead, you'll be allowing sophisticated borrowers to take advantage of the system when our economy has already recovered and mass modifications aren't necessary.
I actually wrote a lot about the threat I believed there was with mass modifications, and so the idea that they are failing is one I cheer. At the same time though, this is a microcosm of President Obama's entire domestic agenda. Here was this grand idea to save millions of borrowers from foreclosure. That's all it was. He had no idea how to make sure that it actually happened. That's because he has no business background. To actually see through so that millions of borrowers did in fact get modified would have required for the administration to market the program and educate the public so that people could figure out if they qualified and how to go about applying. They did none of that. Instead, they announced the program and left the market to its own devices as soon as they announced it. By doing so, they also left a sprouting market to try and deal with millions of these loans. He was totally oblivious to the idea that he was essentially creating a new industry, and this new industry would go through the same growing pains that all new industries go through. At the same time, the industry simply doesn't have the time for these growing pains because in the meantime millions of borrowers will get foreclosed on.
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