In the spring of 2009, the federal government’s Home Affordable Modification Program (HAMP) had prodigious goals aimed at helping up to four million Americans. Mortgage lenders were instructed to modify loan terms of troubled homeowners, reducing their monthly mortgage payment to a maximum of 31% of the homeowner’s income. As an incentive, lenders and loan servicers were given billions of dollars in cash infusions by the U.S. Treasury to rouse them into assisting troubled homeowners. The result: temporarily reduced payment schedules, increased principal balances and extended loan terms, referred to by those in the know as extend-and-pretend modifications. Thus, instead of providing legitimate assistance to homeowners, HAMP bought (and currently buys) lenders time before they inevitably have to declare their losses.

To date, HAMP has been an abject failure. Opposed to the laudable 4 million, only 1.2 million trial modifications were negotiated nationally. Of that, only 66,465 became permanent. In the bout of finger pointing which ensued to account for these poor results, distressed homeowners claimed lenders and servicers lost their paperwork and remained uncommunicative. Lenders and servicers claimed homeowners failed to turn in the proper paperwork during the three month trial modification period, provided inaccurate numbers if they did or they simply defaulted again. [For more information regarding inaccurate number accounting by distressed homeowners, see the December, 2009 first tuesday blog, More leniency for homeowners seeking a modification by fudging their income.]

New loan modification procedures beginning June 1st, 2010 are aimed at untangling this lending knot. Under the new rules, servicers must collect three documents from homebuyers upfront:

  • a loan application, including an explanatory letter detailing why the modification is needed [See first tuesday Form 203 and 217-1];
  • proof of income, such as pay stubs or a profit and loss statement if the homeowner is self-employed [See first tuesday Form 207]; and
  • a form authorizing the Internal Revenue Service (IRS) to release the homeowner’s relevant tax information to the loan servicer. [See first tuesday Form 215 and 215-1]

Stricter timelines have also been put in place in response to homeowners’ complaints about stone-walling lenders. The new rules require the loan servicer to respond to homeowners within 10 days after a request for modification. The loan servicer has one month after receiving the documents referenced above to inform the homeowner whether they qualify for a loan modification.

If the homeowner makes three timely payments under the modified loan terms, it will automatically become permanent. Loan servicers will also be authorized to grant permanent modifications to those loans currently in the trail stage if only minor paperwork is missing from the homeowner.

first tuesday take: Changes  to help more homeowners modify their loans are great. However, these changes do nothing to improve the long-term shortcomings of HAMP.

HAMP still fails to address the underlying problem which vexes most California homeowners in distress: negative equity. Without a cramdown of the loan balance, ideally to 94% of the property’s value so the property can be sold if need be, the troubled homeowner swaps out one financially disastrous condition for another. Without a modification, the risk is high of a future foreclosure. With a modification, the risk is the homeowner’s continual payment on a dead-end loan which will be a drain on the family’s disposable cash and net worth for a decade or so. Paying on an upside-down loan only benefits the lender until the loan-to-value ratio (LTV) is down to 94%.

Thus, even if a permanent modification is granted, most will merely mask the insolvency of the homeowner. Instead of a tether to a way out of financial ruin, it is an imposition of house arrest.

Before pinning their hopes on a modification, distressed homeowners would be wise to prepare a balance sheet of the value of their assets (home, car, furnishings/etc.) and amounts of liabilities (mortgage, credit cards, car loans/etc.) to gain an accurate idea of their financial position. Armed with this knowledge about their net worth, keeping in mind plans for the family’s long-term savings and wealth development, a homeowner can do the math to determine how many years of mortgage payments (modified or not) it would take to restore equity in their property, the point at which the LTV ratio drops below 94%. [See first tuesday Form 207-1]

When it becomes clear it will take some fifteen to twenty years just to break even and return the family to solvency, it is prudent to consider another option inherent in these feckless modifications: strategic default.  The MLSs need more marketable properties at the moment, and since REO properties have equity (free and clear of mortgages), foreclosure seems to definitively answer many of the problems common to a financial crisis.  More foreclosures now will speed up the recovery and allow the California economy to return to full employment that much sooner.  [For more information concerning a homeowner’s strategic default options and their consequences, see the January 2010 first tuesday article, To default or not to default: that is the question.”]

And who better to provide informed counsel to the deliberating homeowner than their friendly agent?

Re: “New rule affects homeowners in foreclosure avoidance program,” from the Los Angeles Times