Bankruptcy & Loan Modifications

As many homeowners have found it increasingly difficult to make ends meat and afford their home mortgage payments, mortgage defaults and foreclosure proceedings have risen.  These homeowners have several options that may put them in a position to bring their accounts current and allow them to make their subsequent mortgage payments.  One such option if a homeowner qualifies is to take part in the United States Treasury Department’s Home Affordable Modification Program.

This program is a shared debt reduction program between your lender and the government.   The first step is for your lender to reduce your monthly mortgage payments including (principal, interest, taxes, insurance and condo fees) to reflect no more then 38% of your gross income.  Gross income is defined as your total salary, tips, dividends and other income prior to taxes.  Once the lender or bank reduced your payments to 38% of your monthly gross income, the Treasury Department will then step in and match dollar for dollar any additional reduction that the lender provides down to 31% of your gross monthly income for up to five years. 

The benefit to a homeowner is rather obvious, in many cases a very large reduction in monthly mortgage payments.  Additionally, should the monthly payment be reduced by 6% or more, homeowners are eligible to receive $1,000 per year for up to five (5) years, payment that goes straight towards reducing the principal balance on the mortgage loan as long as the homeowner is current on their monthly payments.  

In order to  encourage lenders and banks to take part in the program, the lender also receives various significant financial benefits.  First and foremost is their ability to avoid foreclosing on another house that likely has no equity.  The lender shares the financial burden with the Treasury Department; additionally the lender or bank receives compensation from the Government in the amount of $1,000 for each loan modified pursuant to the program.  The lender will also receive up to $1,000 per year for each year the homeowner remains in the program and stays current on their new mortgage obligation.  Should the homeowner be current when entering into the modification, an additional benefit is a one-time incentive payments of $1,500 to lender will be provided.

Granted, this program sounds like a fantastic win-win situation for both a homeowner in financial distress and a lender uncertain as to the borrower’s ability to stay current on their mortgage obligation.  What are the requirements to take part in this program?

Homeowners:

First and foremost, the homeowners, mortgage itself must qualify.  In order to qualify, the loan must have commenced prior to January 1, 2009. 

• The home must be your primary residence and a single family dwelling of no more then 4 units.  More specially, the home may not be investor owned, it may not be vacant.  The homeowner will need to prove they live in home though a tax return or a utility bill.
• The payoff on the primary mortgage must not exceed: 1 Unit: $729,750, 2 Units: $934,200, 3 Units: $1,129,250, or 4 Units: $1,403,400
• A homeowner must have a current or imminent financial hardship.
• Loans can only be modified once under this program, as such, if you have modified once, you will not be able to go back to the well a second time.
• The home must have an appraised or assessed value not older then 60 days.
• The borrower will need to verify their income by submitting an IRS form that allows the lender to request taxes directly from the IRS.  Additionally, the borrower will be required to submit the two most recent pay stubs.
• Borrowers must also represent to the lender that they do not have enough money in the bank to stay current.
• If a homeowner’s overall debt is greater then 55% of their gross monthly income, you will need to first take part in a credit counseling session with an HUD- approved counselor and receive a certificate of compliance.

Lenders:
Participating lenders are required to consider all eligible loans under the program guidelines unless there is a pre-existing agreement which expressly states otherwise.  For any modification request originating from a homeowner in default, a net present value of cash flow test will be applied.  This test essentially looks at whether a modification will increase the homeowner’s cash flow should a modification be granted.

How does the Process work?
The process starts by providing your lender with all the required documentation and information.  This is a step that can be very time consuming and is a prime reason to work with a licensed attorney in your area.  Once the bank or lender has confirmed they have received your full package, and has reviewed the package, a loan negotiator will be assigned to the case.  The lender then must start by determining if there are any missed loan payments in.  If so, the lender may capitalize the late payments.

The next step is for the lender to determine 31% of the homeowner’s gross income.  Once this income level is determined, the lender must follow a 3 step process to reduce the monthly payment to that 31% amount. 

• Reduce the interest rate as low as 2%.   
• If the rate reduction does not bring the mortgage payments down to the 31% mark, then the lender is to extend the duration of the loan to 40 years from the date of the modification.  It should be noted that a full 40 year extension may not be required, but the lender only needs to extend to the point where the payment reaches the 31% watermark.
• The next step is for the lender to forbear principal.  Should interest forbearance be used, no interest will accrue on the forbearance amount.  If there is a principal forbearance amount, a balloon payment of that forbearance amount will due on the maturity date, upon sale of the property, or upon payoff of the interest bearing balance.
• If a homeowner has a junior lien (second mortgage, equity line, etc) and the first or primary mortgage is modified through the program, then and only then can the junior lien be modified.  The Government is offering certain incentives to modify junior liens in this timeline.

The Loan Modification Approval Process

The first step in the approval process is for the homeowner to take part in a 90-day trial period based upon the new loan modification monthly payment.   The borrower must remain current for the first three (3) months or 90-day period.

If the borrower’s total monthly debt exceeds 55% of their gross income, the lender or bank must notify the borrower in writing of HUD approved credit counselors.  The borrower must complete a credit counseling program and obtain a certificate.  If the homeowner’s debt does not rise to the 55% level, the forgoing is not required.

The lender must waive any late fees upon completion of the 90-day trial period.

The investor may not require the borrower to contribute cash

What about homes in foreclosure?

Subsequent to a modification agreement being entered into by the homeowner and the lender, any foreclosure action will be temporarily suspended during the 90-day trial period, In the event that the Home Affordable Modification or alternative foreclosure prevention options fail, the foreclosure action may be resumed.  However, pursuant to the Affordable Home Modification Program, should the modification fail, banks and lenders are required to consider other programs before foreclosure including but not limited to short sales and deed in lieu of debt.

If you found this article helpful but would like to work directly with an attorney who handles these matters, you may want to contact a local bankruptcy or debt relief law firm, such as the author of this article, The Law Office of Goldstein and Clegg, LLC, Loan Modification Attorneys.

A common practice in the mortgage industry is to buy and sell mortgages. This practice has a specific legal term, “assignment”. What many lenders have tried to do though is to buy mortgages that have a foreclosure order already on record. The new lender then buys the loan at a very deep discount and tries to sell the house though the foreclosure process. This slick strategy on the part of lenders has been deemed illegal in Massachusetts. More importantly, pursuant to a recent Massachusetts Land Court case, any foreclosure on record that is assigned has been reversed and ordered void.

More specifically, in the Land Court case of, US Bank National Association v. Ibanez (Misc. Case No.384283), where the foreclosing lender was assigned a mortgage dated prior to the date of publication of notices under M.G.L.c. 244, Section 14, the mortgagee had no title to foreclose. Basically, the court has effectively invalidated every foreclosure sale where the foreclosing party could only produce an assignment dated after the date of the publication but with the stated effective date of the assignment prior to the publication date.

The legal ramifications of the aforementioned case are highly significant. As long as the assignment vesting the title into the mortgagee did not physically exist at the date of the publication of foreclosure sale notices, the foreclosing entity was not the mortgagee within the meaning of M.G.L.c. 244, and thus had no authority to foreclose.

            In the past, “Foreclosure” and “Bankruptcy” were considered two of society’s dirty words.  Today these terms are viewed by many as relief from Financial Black holes that can not otherwise be escaped.  In the current economy, inundated with bad mortgages, many of which stem from predatory lending practices, coupled with credit card debt spinning out of control, bankruptcy and the loss of ones home have become common place.  For many homeowners, a decision needs to be made as to which of these terms is the lesser of two evils.

            For homeowners whose debt has spun out of control, and whose income does not cover expenses, foreclosure and or bankruptcy are options that may be inevitable.  However, which of these terms truly is the lesser of two evils? 

            Should a homeowner file for bankruptcy, they may be able to eliminate all of their credit card debt, medical bills, court ordered judgments and even electric and gas bills.  With the assistance of a bankruptcy discharge, they may then be able to stay current on their mortgage.  However, many people are even more concerned about their credit score.  They may ask, “Will we be able to obtain future financing?”

            Should a homeowner rather, opt for foreclosure, they will certainly loose their home, but do they really want to keep it in this market where the house may be worth far less then what is owed.   If a homeowner opts to walk away from their house, they may own other investment property, and be able to live in a multi-family house, or they may simply want to rent and not deal with all the hassles of homeownership.  “If something breaks, let someone else fix it, repair it, deal with this problem”. 

           Neither option is an easy choice.  A bankruptcy will remain on your credit for 10 years, while a foreclosure will only remain for 8 years, but many credit counselors report it has twice the negative impact on your credit score compared with a bankruptcy. It will be extremely difficult to obtain a new mortgage for many years after you have lost a home to foreclosure.  Many homeowners may see foreclosure as a better option then simply obtaining the financial relief that the Bankruptcy Laws provide.  What many do not realize is that a foreclosure may be even a darker mark on their credit then a bankruptcy.  As a result, it may be even more difficult with a foreclosure on their record to obtain subsequent housing.  Many mortgage lenders look at a foreclosure more seriously than they will a bankruptcy.  As a result, a former homeowner may not qualify to rent the apartment or house they want, even though they may be able to afford it now that the mortgage obligation is gone. 

            One of the key factors to keep in mind is that when you file and receive a discharge of your debt in a bankruptcy, even if your credit score is lower, you are still a better candidate to receive future financing and in very short order.  The reason is simple.  After your bankruptcy discharge, you do not owe anything to anybody.  Additionally, creditors realize that you can not file for a new bankruptcy for another eight (8) years, and as such can not walk away from any new debt that you may incur as a result of credit extended to you by a new creditor, be it landlord, credit card, or other financing option.

            Now it should be pointed out that in many cases, you may be so far behind that a foreclosure is going to happen no matte what.  If this is the case, it may be in your interest to file for bankruptcy right before the order.  The reason is that if the bank sells the property for less then what is owed, the difference (commonly referred to as the deficiency) will be discharged.  As a result, the bank will often sit on a foreclosure order for some time before they act upon it, so as to not loose more money.  In the meantime, a homeowner can possibly short sell their house and move on with their life.

            Based upon the foregoing, if you are facing a financial crisis that may end in either foreclosure or bankruptcy, consult an attorney to explore what your best option may be. The right decision may save you years of restricted credit in the future.

As a bankruptcy attorney and a lawyer who represents clients with loan modifications, I am often faced with a client who owes more money on their home then the house is worth.  This negative equity situation is often referred to as being “upside down”.  One of the biggest questions I am asked by these homeowners is how much can I save with a loan modification. 

Pursuant to President Obama’s Home Affordable Modification program, a homeowner’s mortgage payment should not exceed 31% of the household income before taxes.   To that end, the Federal government has created a Payment Reduction Estimate Calculator that will demonstrate how much or if at all you can expect savings through a loan modification.  You can view this calculator at: http://www.makinghomeaffordable.gov/payment_reduction_estimator.html

I recently came across a very interesting article regarding relief for homeowners through loan modifications (or as I like to call it, renegotiation of your mortgage terms) on Business Week Online. 

The growing urgency to implement an effective fix for the deepening U.S. financial crisis is pushing policymakers to consider measures that were roundly rejected as too risky not very long ago. The limited success of the first $350 billion in TARP funds and the government’s wavering on how best to dispose of the toxic assets that are clogging banks’ balance sheets — and preventing a rebound in the credit markets — has added to the sense of urgency.

Former Treasury Secretary Henry Paulson favored using the financial rescue funds to recapitalize banks and other institutions seen as most critical to the health of the global financial system. But persisting doubts about the quality of assets on banks’ books amid further deterioration in home prices has stymied the government’s efforts to make inroads toward reviving the financial industry. Now that the estimated number of U.S. home foreclosures may be as much as four times the 2 million projected in late 2007, more serious attention is being given to the idea of using taxpayer money to get at the meat of the problem: the underwater mortgages that precipitated the whole mess. There are efforts afoot to improve the success rate of home loan modifications [popularly known as “mods”], which basically change the terms of the mortgage in question to improve the odds that the homeowner will be able to keep up with monthly payments. Fewer busted mortgages, the thinking goes, will lead to fewer foreclosures, which could potentially slow the rate of decline in home prices… 

Read more about New Proposals For Modifying Mortgages

Homeowners who can’t afford their mortgage payments can get a better deal from their lender. Loan modifications or mortgage modifications are designed to keep the homeowner in their homes though changing the terms of their existing mortgages to something more affordable for the homeowner. Refinancing on the other hand aims to simply pay you’re your existing mortgage by securing a new mortgage, at a different interest rate, or term of years, coupled with a host of closing costs. The key to remember is that a refinance doesn’t pay off the debt; it just restructures it, and generally adds to the principal owed.

An “affordable” payment typically is defined as a specific percentage of the borrower’s monthly gross income.  The common targeted range falls between 30 and 40 percent.  The modified payment must be sufficient to pay off the loan, sometimes with the term extended to 40 years and in many cases with some of the principal deferred until the loan is refinanced or the home is sold.

Many homeowners who are in high interest or variable rates believe refinancing is their best option.  However, refinancing your mortgage can reduce your overall financial benefit as opposed to a loan modification. Those who refinance will pay a heavy price by incurring many thousands of dollars in closing costs.

In order to justify the massive closing costs associated with refinancing, a homeowner should intend to be own their house for quite some time in order for refinancing to make sense. According to an August 2008 report on Bankrate.com, the national average for closing costs on a $200,000 loan is $3,118. The fees in the survey don’t include additional taxes, mortgage insurance or any prepaid items such as prorated interest or homeowner association dues, which can add several thousand dollars more.

If you are considering refinancing, you should calculate how many months you will need to stay in your home simply to pay off the closing fees.  On the other hand, there are no closing fees, no additional taxes or insurance and no pre-paid items incurred through a loan or mortgage modification.  For example, if your monthly payment goes down by $165, it would take 20 months of lower payments to recover the average closing fees.
If you are in a newer mortgage, there is also the potential to incur a prepayment penalty on your mortgage should you refinance too soon.   As such, if you’re struggling to make your mortgage payment, a mortgage modification may be much more advantageous for you then refinancing.

There are many types of loan modifications that may be offered by your bank such as:

• Repayment plan
• Interest-rate reduction
• An extended payback period (usually 40 years)
• Conditional forbearance
• Foreclosure stay
• A deferral of principal (usually at zero interest).

The one caveat to consider in choosing a loan modification rather then refinancing is that loan modifications are designed to prevent unnecessary foreclosures. They are not about creating great investment opportunities.