Homeowners Worse Off After Mortgage Modifications?

There are several options to foreclosure and the three most popular are short sales, deed in-lieu of foreclosure and mortgage modifications. Under the Obama administration they have created the Making Home Affordable Program which is a $75 billion initiative in addition to the hundreds of billions in bail out money.

Many of my customers first try a mortgage modification and usually get a much less than desirable solution from their mortgage service provider. In almost all cases there is no reduction in principle and most clients do not qualify under the Making Home Affordable Guidelines of your mortgage being more than 125% of it current appraised value. That means, that if you have a $125K mortgage and your home appraises for $99K then you do not qualify under this program.

I just read an article that discusses how tens of thousands of financially strapped homeowners who have asked lenders to lower their mortgage payments are instead winding up with higher monthly payments and larger debts on their homes. This is disturbing news, but not surprising.

Homeowners who were hoping for lower payments are discovering to their dismay that lenders roll late fees, back taxes or other costs into the principal, sometimes turning a difficult payment into an impossible one. That is one reason that many reworked mortgages are sliding back into default.

It’s too early to know if this pattern will continue under the Obama administration’s $75 billion initiative to get lenders to reduce monthly payments for homeowners struggling to make their mortgages. A total of 360,165 mortgage modifications are now in a three-month trial period under the government’s plan announced in March. But the initiative focuses on reducing interest rates rather than cutting principal, which has been found to be one of the most effective modifications for helping homeowners avoid defaulting a second time (known as a “re-default”).

Of loans modified from Jan. 1, 2008, through March 31, 2009, monthly payments increased on 27 percent and were left unchanged on an additional 27.5 percent, according to a recent report by banking regulators. Many modified mortgages fall delinquent – 25 percent to 40 percent, depending on the type of mortgage – often because of homeowners’ loss of income or additional outstanding debt, according to a report last month by CreditSights, a financial research firm.

“Payments have gone up … (and) the payment relief can last for the first few years and then go up (again),” says Alan White, assistant professor of law at the Valparaiso University School of Law in Valparaiso, Ind. He has studied the subprime mortgage situation for 10 years. “(The lenders) focus on today and not on the future.” Even under the Obama plan, they don’t focus on permanent debt reduction, White says.

The majority of borrowers who’ve gotten mortgage modifications have seen their overall principal balance go up, according to an analysis by CreditSights and ICP of about 660,000 mortgages modified this year. In about 90 percent of the modifications, the principal balance after a modification was larger, CreditSights said.

Hit with a 1-2 punch

That’s the situation facing Samantha and Steve Jensen. When the couple bought their $550,000 home in Scottsdale, Ariz., six years ago, they thought they’d found the perfect place to raise their three children.

But when their adjustable-rate mortgage reset to a higher rate, they could no longer afford the monthly payments that jumped by about $1,000 a month, to $3,300. So they were relieved when their bank in June offered to modify their mortgage by lowering their interest rate.

Under the modification they were to pay $2,600 a month – but then they discovered they also had unpaid property taxes. Once the bank added taxes to their principal, they say, their monthly mortgage payment grew to $3,500. They got a modification in June and are now two months behind on their mortgage payments and facing possible foreclosure.

“The bank could have done more and reduced our principal,” says Samantha, 40, a special education teacher. “You have the anticipation of relief and then you realize it’s not going to make it better. It’s like being punched in the stomach twice.”

How most modifications work

A mortgage modification can take several forms. Lenders may allow borrowers to skip payments and then add the skipped payments to the amount of the loan. They may reduce the interest rate charged, extend the loan term, or reduce the total amount of the loan by forgiving principal.

Many lenders say that reducing principal remains the modification of last resort.

More than 80 percent of loan modifications that Wells Fargo has done in the past three months have led to lower payments for borrowers, but most involve rate reductions, the bank says. Wells Fargo has done more than 240,000 modifications, and more than 30,000 of those have been under the Obama administration program.

At CitiMortgage, about 92 percent of modifications involve reducing rates, lengthening terms of the loan, or both. About 8 percent provide principal reduction.

Providing relief to borrowers is complicated because of the financial interests of the parties on the other side of the loan. Many mortgages are commonly sold to investors, and borrowers’ payments are collected by servicers, which may be the original lender or a different company.

Certain types of loans cannot be modified without the investors’ approval. Lenders and investors may shy away from reducing a mortgage’s principal balance because that requires them to write down the value of the loan. But temporarily reducing interest payments while adding to the mortgage’s principal avoids any loss.

Some research suggests lenders may gain financially if they don’t modify a mortgage at all.

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Note: The information provided is for informational purposes. No legal advise is given or implied. Please check with a qualified attorney in your area.