Bad News For Loan modificationsLoan modifications have been fading in and out of favor since the idea was floated that the federal government could pick up a portion of the tab for lenders being willing to grant them. modification is a change to the terms of the mortgage to reduce the principal, forgive some interest, or drop the interest rate. Basically, anything that changes the terms of the original note. Banks have been slow to grant them, for reasons that have been detailed here and here on this blog (there are some really good posts on this topic). Now there’s more bad news. For those attempting to get a modification, and even for those lucky few that have been successful.

First, the majority of those attempting to get a modification are seeing related negative items appear on their credit. Our office has an endless parade of people that have been making exactly the payment dictated by the lender in the trial period, complete with back-up documentation for multiple months. They have never missed a payment or been even 10 days late. And yet, their credit shows a long string of 30-, 60-, and 90- day late payments on their mortgage. In other words, the lender negotiated a trial payment, then began marking the borrower late when those payments were made. Can this be sorted out? Probably. Is it a massive headache, and a potential catastrophe? You bet it is. The borrower is often legally in foreclosure. At the point where the lender believes that foreclosing will be financially beneficial they can do so that very weekend.

Now the lender actually has an additional incentive to drag its collective feet in taking care of the modification. Now 23 states have a de facto foreclosure moratorium, lenders may start taking even longer to grant the official contractual modification, because they will now need a large increase in staff in the foreclosure and loss-mitigation departments to meet the increased burden of proof in handling judicial foreclosures. That staff is going to come from the modification department, not the underwriting department or the unemployment line. Reduced staffing = more delays. Get used to it.

But if you get through the process and actually get the modification, you’re out of the woods, right? Wrong.

Suppose you get the modification taken care of. Your job changes and you get a better offer somewhere else. You’re next step is to get pre-approved for a new loan for a home at your new location. You’re denied. Why? Because your current lender has reported on your credit that you have obtained a modification. Once a new lender sees it, your loan is dead. Most lenders have issued credit overlays for mortgage modifications that treat them as pre-foreclosures, and require 48 months from the date of the modification before a new loan is eligible.

Right. A notice of default and a modification have the same credit impact from a refinance or a purchase standpoint. Should you get a modification, you better stay in that house, with that loan, for four years. (Or have a wheelbarrowful of cash).

Personally, I think contractual modifications are a great idea. Commercial loans have been almost infinitely modifiable for centuries. Circumstances change, and if the parties to the contract want to alter the original terms of the agreement, why shouldn’t they be able to? But the way things have turned out with the wave of modification attempts in the residential markets, it might have been better for everyone if the concept never existed at all.

  • Lewis Poretz

    Great points Chris….

    Lenders are dinging credit for trial modifications that have been turned down by claiming clients are 3, 4 even 5+ months late, all as a result of the sluggish loan mod process. Lenders claim once the trial mod is denied the money is first applied to each month late. Trial mod payments are always lower than the existing payment. The difference in the normal payment and the trial mod payment then causes a deficiency that needs to get caught up, which triggers your payment history to immediately go several months behind.

    Really it is just an accounting game. So now we have a homeowner that always paid on time, who simply wanted to take advantage of a government created loan modification program, and now they could potentially be 90+ days behind because of how the money is applied. At 90 days the foreclosure process starts….And the only way to cure it is to pay the entire deficiency…. plus attorney and collection and all the other junk fees…. Homeowners are left wondering what the heck they got themselves involved in. I have seen too many people first hand lately that have been burnt by this process.

    As for your point on contractual modifications…. let me ask this – If a big business such as, say Citi or AIG or GM or Fannie Mae was having revenue issues, do you think they would hesitate to go to their creditors and negotiate new terms? Of course not. And their bankers want to get them in a position where the loan performs…so why is this not true for home loans??

    American consumers are adapting to the depressed economy. I really believe that. They are spending less and saving more. Many homeowners have the ability to get back on their feet but are behind on their mortgage. I believe if lenders aggressively came up with a plan to cure any deficiency either by forbearance or forgiveness, and aggressively followed modification guidelines, and most of all commit to finding a solution to help consumers it would benefit the entire economy. Should the economy worsen and a new wave of foreclosures hit, which will force property values down more, we will see a wave of strategic defaults like never before.

  • Chris Jones

    Excellent points. Strategic defaults are a serious and growing problem, and an increasing number of people being stuck in properties they don’t want to live in leads to more of those. Making a loan mod equal to a pre-foreclosure is not going to make this problem easier to deal with.

    And don’t think a foreclosure moratorium will fix that problem, either, because on the borrower’s side it will then be easier just to stop paying at all, rather than go through the full-body scan that a mod requires. Lenders are even now pulling experienced staff into the foreclosure department to try and forestall any moratorium, and where do you think those people are coming from? Right. The mod departments. That ought to speed things up.

    Great comments, Lewis.

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  • Cynthia Tilleman

    Great points about Loan Modification. I am sure most people do not know about most of them, especially the hit on your credit score.

  • Chris Jones

    Most people do not. Heck, most loan officers don’t.

    What it means is that a loan mod is terrific if you’re going to lose your home without it, but if you’re not, it’s a lot better idea to go for a traditional refinance.

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