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Friday, June 26, 2009

Loan Modification Simplified

Loan modification is a revision in terms of a loan which results in alterations in interest rate, the principal amount or even the kind of loan program you are on.

Traditionally, standard refinance is more common as compared to loan modification. The necessity for altering the conditions or terms of the loan is essentially due to the difficulty the borrower may be facing in paying back the loan as per the originally agreed terms of the loan. Homeowners that default in payments have very difficult decisions to take as a consequence to the default. Some of the options available are a) foreclosure; b) short sale or c) Loan modification.

Of these there options it is only under loan modification that the homeowner can retain possession of the house. In such a case, if the borrower is able to prove that they can make good the payment under revised terms, in a consistent and timely manner, will the bank consider allowing a loan modification. The change in terms could be increasing the amortization period (40 or 50 years), principal balance reduction, forbearance clause, temporary or permanent interest rate reductions or including an interests only option. (please refer to the Glossary for a better understanding of the italicized words).

The basic objective of loan modification is to allow the homeowner the opportunity of making the specific quantum of payment that he/she can reasonably pay after considering all monthly expenses. The bank would consider all aspects of the borrower's expenses like phone payments, credit card liabilities, electricity, gas and water charges and the like. The bank would not require the borrower to spend all his monthly income on financing the mortgage as this is practically not feasible and reasonable. Hence, the loss mitigation department of the bank will consider all reasonable expenses for maintaining a normal lifestyle while calculating a reasonable monthly mortgage payment requirement.

Loan modification is a negotiation process between the borrower (you, the homeowner) and your lender (the bank). In some cases you may have a modification company deal with the bank on your behalf. The process involves submission of a proposal along with an Income Vs. Expenses Statement which you will see in the worksheet at the end of this book. This statement presents to the lender the sum total of your household income post taxes. Also, there is an estimation of your monthly expenses which include hard as well as soft expenses. Softy expenses are not so easy to identify and document. If the soft expenses are overestimated, you will be able to estimate the cash. The Income Vs. Expense Statement presents your monthly income which you can then compare with the expenses excluding the mortgage payments. The difference between the total income and the expenses is equal to the revised monthly mortgage, with the understanding that you would have left some surplus for incidentals in your expense side while preparing the loan modification proposal. Leaving nothing for incidentals is not at all practical.

Negotiation with the lender is the step that follows presentation of the loan modification proposal including the Income Vs Expenses worksheet. Negotiations will be dealt with later in this book.

Principle balance reduction having 1st and 2nd Mortgage

When you have first and trust deed holders, pursuing and getting principal balance reductions become simpler, mostly because the 2nd trust deed holder will get hardly anything in the case of foreclosure. When a foreclosure happens, the 1st deed holder is paid off and only any residual amount gets paid to the 2nd holder. In most cases, the 2nd holder is faced with huge losses and recovers very little, of any. That's why the 2nd holder is in favor of allowing some reduction. As the bank would like to get at least 10-20% they would certainly not like a situation where you lose your house and they make losses, due to which they would like to prevent such an occurrence by any means.

When you have 2 mortgages holders you can have 2 conditions: 
a) Where both notes are held by one bank and b) where the 2 notes are owned separately by 2 different banks. The first scenario is best for a principal balance reduction. They would rather securitize the first because the 2nd is mostly of no value to the lender. The 2nd could be brought down as low at one-tenth (10%) of what is currently outstanding provided they are convinced that you can pay off in time and consistently. Rarely would a bank reduce both the first and the second when payments are in jeopardy.

Reductions can be different if both mortgages are held by separate banks. A bank that owns just the second would look at the single note to ascertain losses. If a bank holds both notes, it would be reasonable to expect that the bank would forgive up to 90% of the 2nd to prevent bigger losses. But second trust deed holders realize that on foreclosure they would lose all, so they would allow principal balance reduction, even though it may not be easy. This realization often prompts the 2nd holder to push for a negotiation and prevent foreclosure.

If you want a favorable settlement you have to convince both banks to lower the balance as this could work out well not only for you by spreading the losses but also for the banks.

If you want to deal with a modification company, be careful that you do not get cheated to add to all your debt woes.


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