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 How does a loan modification effect a person's taxable income? 

1.      The general rule is that when debt for which a person is liable is canceled or forgiven, the canceled amount must be included in a party’s reported income.

Generally, if a debt for which a person is personally liable is forgiven, the forgiven amount must be included in that person’s income.   The IRS defines debt to include any indebtedness for which one is personally liable, or subject to which one holds property.  If a person is not personally liable for a debt, the cancellation income will need to be included if a person retains the collateral and either: (1) the lender offers a discount for the early payment of the debt, or (2) the lender agrees to a loan modification that results in the reduction of the principal balance of the debt. 

2.      There is an exception to the general rule for debt incurred to finance the purchase, construction or substantial improvement of a person’s residence.

 A person can exclude canceled debt from income if it is qualified principal residence indebtedness.  Qualified principal residence indebtedness is any mortgage a person took out to buy, build or substantially improve his or her main home.  The mortgage must be secured by the main home.  A person’s main home is the home where he or she ordinarily lives most of the time.  A person may only have one main home at any one time.  The IRS has not provided guidance on what it considers a “main home,” but does say it will look at the facts and circumstances in every case.  A person is limited to excluding $2 million of qualified principal residence indebtedness.  If a person excludes canceled qualified principal residence indebtedness and continues to own the home after the cancellation, the person must reduce the basis of the home by the amount of the canceled indebtedness, but may only reduce the basis to zero.  The legal authority for this memo comes from IRS Publication 4681, except where other authorities are cited.

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Lately I've been fielding calls from individuals that have obtained what are called "forensic audits" of their mortgage documents.  Usually, this is in conjunction with a difficult scenario that they have found themselves in, where they are behind on their payments and are looking for any ammunition to defend against a foreclosure.  In theory, a forensic audit is straightforward: a company will comb through your mortgage documents for "violations" or other signs of misconduct by the lending institutions.  This is usually not too difficult a task given that many of the regulations that control these transactions are extremely technical.  Violating them is easy, in other words. 

The bigger issue is what to do with the violations when they are discovered.  There has not been a tremendous amount of precedent in this regard (at least in Washington, there hasn't been), but I would advise against the notion that faulty mortgage documents equal borrower keeping home.  That is not likely to happen for a few reasons -- first, the bank did loan money out to the individual, which technically, would need to return the funds if the transaction were undone and reset; second, the parties relied and acted upon the loan.  A court could reset the entire mortgage and order that, if possible, the parties be put back to their proverbial starting points.  This obviously present a problem in and of itself, given that the home may be underwater and the borrower may not have the funds to refund the bank for the money issued in the original loan.

So, in short, for those of you leaning on a forensic audit as the resolution to your mortgage predicament, I'd make sure to have a backup plan. 

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According to a recent article, many experts are predicting that the foreclosure crisis will continue through 2011.  Currently, there are about 5 million borrowers at least 2 months behind on their mortgage payments. 

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On November 19, 2010, the Federal Trade Commission (FTC) issued 16 C.F.R.  Part 322, the Mortgage Assistance Relief Services Rule (MARS) concerning providers of mortgage relief service.  While many relief providers are legitimate, “At a time when many Americans are struggling to pay their mortgages, peddlers of so-called mortgage relief services have taken hundreds of millions of dollars from hundreds of thousands of homeowners without ever delivering results,” FTC Chairman Jon Leibowitz said.  Unlike an attorney assisting a client  in a loan modification or short sale effort, many mortgage relief services do not have a good understanding of the consistently changing rules and laws (both state and federal) involving mortgages and foreclosures and are not subject to code of ethics.     

The MARS Rule is designed to protect distressed homeowners from these mortgage relief scams.  The most significant new rule under MARS is that non-attorneys offering mortgage relief services may not collect any fees until:

1.     The company has provided the consumers with a written offer from their lender or loan servicer that the consumer decides is acceptable.

2.     The company has provided the consumers with a written from the lender or loan servicer describing the key changes to the mortgage that would result if the consumer accepts the offer.

3.     The company must remind the customer of their right to reject the offer without charge.

The MARS Rule also requires mortgage relief services to disclose key information to customers, including that the company is not associated with the government or the customer’s lender and that the lender may not agree to change the customer’s loan.   In addition, it the company tells the consumer to stop paying their mortgage, they must inform the consumer that this could cause them to lose their home and damage their credit rating. 

In addition to the mandatory disclosures, the MARS Rule prohibits mortgage relief companies from making false or misleading claims about services, including claims about:

·       the likelihood of consumers getting the results they seek;

·       the company’s affiliation with government or private entities;

·       the consumer’s payment and other mortgage obligations;

·       the company’s refund and cancellation policies;

·       whether the company has performed the services it promised;

·       whether the company will provide legal representation to consumers;

·       the availability or cost of any alternative to for-profit mortgage assistance relief services;

·       the amount of money a consumer will save by using their services; or

·       the cost of the services.

In addition, the rule bars mortgage relief companies from telling consumers to stop communicating with their lenders or servicers. Companies also must have reliable evidence to back up any claims they make about the benefits, performance, or effectiveness of the services they provide.

Attorneys are exempt from this new rule as long as they are engaged in the practice of law, licensed in the state in which the consumer or home is located, and comply with the State’s ethics rules.  These are requirements that any practicing attorney should meet anyway.  In addition, and fees attorney’s collect will be placed in a client’s trust account and only withdraw for work performed in accordance with the retainer agreement the client has signed.         

All provisions of the rule except the advance-fee ban will become effective December 29, 2010. The advance-fee ban provisions will become effective January 31, 2011.

Source: http://www.ftc.gov/opa/2010/11/mars.shtm

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According to this article from the LA Times, the Federal Trade Commission (FTC) is starting to "clamp down" on phony loan modification companies.  Essentially, starting January 31st, loan modification companies will be prevented from getting upfront fees.  The evaluation by the FTC is simple: "[i]f a [loan modification company] seeks to charge you anything or collects money upfront, it will be in violation of federal law and subject to harsh penalties."  For loan modification companies to continue, they will have to "contact your lender or servicer and give you a written proposal describing the key changes to your mortgage terms that the note holder [usually your lender] is willing to make before any more money can be collected in advance."  In essence, loan modification companies are will be required to complete a pre-loan modification modification, before they can execute a final loan modification, at which point, they may be paid for their services. 

The articles goes on to report that attorneys are largely exempt from the law: 

The only exception will be for lawyers, who typically require retainers before they begin negotiating on a client's behalf. They will be permitted to collect retainer fees for modification efforts but only if they deposit the money into "client trust accounts" under state bar regulations. Lawyers who charge advance fees also must be licensed by state authorities and be in compliance with state laws and regulations governing professional conduct.

This new regulation from the FTC is bound to frustrate many loan modification scams that seek to obtain funds from clients, but then provide nothing in return.  Fortunately, the FTC leaves in place law firms to handle upfront fees. 

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This blog post from the Seattle Bubble Blog is quite informative about the most recent foreclosure assessment for the Seattle area.  Perhaps we are starting to see the second waive of foreclosures? 

Though I'm sure we will eventually turn this market around, it seems to be clear that we are in it for the long haul.  It does not help with the recent news that Colliers closed its offices in Tacoma, and GVA Kidder Mathews intends to drop its affiliation with GVA (national brand/presence) in the coming months. 

One can't help but wonder whether or not the days of consistent 6–9% annual home appreciation are gone…at least for the foreseeable future. 

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If you’ve ever tried to modify a Loan through a Bank, then you already know one thing:  Banks can often make the process so difficult it doesn’t even seem worth the effort.  This is what separates the accepted applicant from the denied applicant.  In 2010, every creditor / lender / Bank has figured out one thing… some people won’t follow through with their loan modifications if you make the process difficult.  Borrowers will falter, hesitate, miss a deadline and POOF! their opportunity to modify their existing loans has passed.  Don’t be that borrower.  Here are a few tips from the trenches of the Battle for Loan Mods being fought daily:

1)        Never give up.  Be relentless.  The lender is not going to push your case through the system – that is your job.  So eat healthy meals, exercise, and lift weights because getting a loan modification is like participating in an athletic event.  It is tiring, requires personal strength, and certainly demands some serious stamina.

2)       Be well-informed.  Read all of your loan documents.  No matter how boring they may seem, being a smart debtor makes you a valuable debtor.  If you have two mortgages, keep your first mortgage and your second mortgage separate in your mind.  Also, check out the website for your lender.  Visit the Bank’s websites, learn about their departments and practices.

3)       Be well-prepared.  Always keep your loan information spread out, with the most important pages on top, when you’re ready to call the lender.  Have your notes from previous phone calls ready to answer questions.

4)       Take notes.  Keep track of every name, extension, and job title of every person you speak with during a phone call to your Bank.  Remember, employees at the Bank, like anywhere else, can move, be reassigned, forget, or misplace information.  That’s where you step in and lead them in the right direction.

5)       Keep a calendar.  As you learn about important deadlines, write them down on a calendar (or, if you are tech saavy, you can use Exchange or an open source alternative) and keep a reminder note about a week out.  When your reminder hits, call the bank and make sure you are in compliance for that step.  Ask if there is anything else you can do and be prepared to hustle any documents they need out the door that day.

6)       Get your documents in early every time!  Always send in your documents as soon as you can and then call and verify that they were received by the Bank.  Never assume that they received your documents just because you faxed them in.  Lenders rarely complain if you send too many copies, so back up your emails with letters and your faxes with certified mail!

7)       Finally, never give up!  You are a rock, strong and unbending in your determination to modify your loan.  You are an arrow, aimed at your goal of a loan modification and focused on helping your creditor find reasons to approve it!

The loan modification process is not a sprint, it is a marathon.  You must be prepared, informed, and studiously devoted to your own cause.  If you cannot find the time to devote to this process, hire someone who can.  If there are issues or questions you can’t answer, ask an expert.  Whatever happens, don’t give up!  For more information on loan modifications, follow this link to a fantastic collection of past blog entries devoted to loan modifications.

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Often times, people who have second mortgages believe they are essentially shut out from the loan modification option.  This may not be true.  The government has a program which may assist those who wish to modify their current loan, but who also have a second mortgage.  This article discusses the options in general detail. 

For even more information, look at the government's website here. 

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According to this article from Reuters, banks are still hesitant to carry through with loan modifications.

http://www.reuters.com/article/idUSN2419665720100624

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The month of May showed a mixed bag of real estate sales statistics for the Seattle area, with an increase in pricing, but softening of inventory.  Apparently, the small bounce in pricing is related directly to the impact of the tax credited offered by the federal government.  Now that it has expired (or is expiring as the last sales close), it will be interesting to see the impact.

Here is the full story. 

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http://blog.seattlepi.com/intelligentinvestor/archives/212001.asp

The above link provides an exhaustive outline of what someone interested in purchasing a foreclosure/short sale home should consider. 

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This article in Business Week outlines the ongoing (and troubling) picture of the US housing market:

http://www.businessweek.com/news/2010-06-23/housing-market-threatens-u-s-recovery-as-sales-slide.html

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A Seattle law firm, Hagens Berman Sobol & Shapiro, has filed a lawsuit against Bank of America over its apparent failure to satisfactorily distribute TARP funds to stem foreclosures. 

According to a press release by Hagens Berman, Bank of America has made an "affirmative decision to slow the loan modification process for reasons that are solely in the bank's financial interests."

It will be interesting to monitor how this suit develops, as it strikes at the core issue of whether the government's injection of capital into the banking market actually resulted in a positive result. 

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After the first attempt by the Obama Administration to stem the foreclosure tide fell flat (only a fraction of eligible home owners facing foreclosure secured permanent modifications), the federal government is proposing a broad new initiative.

The New York Times reports that the government will now try to reduce the principal for home loan modifications.  To do this, it intends to provide a program by which those who are "underwater" (home value less than what is owed) can refinance into a government-backed mortgage.

This is significant because most (if not all) loan modifications up to now consisted of banks largely shifting interest rates and extending payment terms.  Thus, the actual principal of the loan was never really effected, merely the interest.  As a result, the underlying problem which plagued a lot of homeowners was never truly addressed (that they simply had purchased homes which were beyond their budget). 

To fund this new program, the government intends to utilize $50 billion funds previously allotted to the Troubled Asset Relief Program, more commonly known as "TARP."  Though reaction from many non-profit groups is generally positive, it remains to be seen whether banks will cooperate with the new program. 

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In determining whether to grant a loan modification, there are generally three central factors that a lender takes into consideration: 1) the financial hardship of the borrower; 2) whether the borrower is currently delinquent on mortgage payments or is at risk of becoming delinquent in the immediate future; and 3) the borrower’s debt-to-income ratios. While the first two factors seem relatively straightforward, understanding your debt-to-income ratios is oftentimes confusing and may seem complex.

What is a debt-to-income ratio?

Simply put, a “debt-to-income ratio” (DTI) is the percentage of a homeowner’s gross monthly income that goes toward paying the homeowner’s debts. In the context of a home loan modification, two DTI ratios are considered: a “front-end” DTI ratio and a “back-end” DTI ratio.

Why are Your Debt-to-Income Ratios Important?

Because lenders want to avoid as much risk as possible, they will pay special attention to your DTI ratios. In essence, lenders use your DTI ratios as indicators of your ability to repay your debts. Therefore, if your DTI ratios are low, lenders may be more inclined to assist you because they believe that you have a higher probability of repaying your debts. On the other hand, if your DTI ratios are high, lenders may be less likely to assist you because they believe you have a lower probability of repaying your debts (and, therefore, you are a greater risk).

Because your DTI ratios play such a significant role in the home loan modification process, it is a good idea for you to do a rough calculation of your own front-end and back-end DTI ratios before seeking a loan modification. By doing your own calculation, you can estimate whether a lender is more likely or less likely to grant you a loan modification.

How Do You Calculate Your Front-end DTI Ratio?

To calculate your front-end DTI ratio, you divide your total “monthly house payment” by your gross monthly household income:

           Monthly House Payment ÷ Gross Monthly Household Income= Front-end DTI Ratio

Your “monthly house payment” is often referred to as “PITIA.” “PITIA” is defined as principal, interest, taxes, insurance (including homeowners insurance and hazard and flood insurance) and homeowners association fees (if applicable). Note that if you pay property taxes, insurance, and/or homeowners association fees separately from you mortgage principal and interest, these expenses need to be added to your total “monthly house payment.”

Examples

1)    Mr. Smith’s monthly house payment is $1,100. Mr. Smith is a carpenter and his gross monthly household income is $2,700. To figure out his front-end DTI ratio, Mr. Smith takes the amount of his monthly house payment ($1,300) and divides it by the amount of his gross monthly household income ($2,700). Mr. Smith’s front-end DTI ratio is 40.7%, because $1,300 ÷ $2,700= 40.7%.

2)    Mr. and Mrs. Baker’s monthly house payment is $1,900. Mr. Baker is an electrician and his gross monthly income is $2,800. Mrs. Baker is a seamstress and her gross monthly income is $1,200. Combined, Mr. and Mrs. Baker’s gross monthly household income is $4,000. To figure out their front-end DTI ratio, the Bakers take the amount of their monthly house payment ($1,900) and divide it by the amount of their gross monthly household income ($4,000). The Bakers’ front-end DTI ratio is 47.5%, because $1,900 ÷ $4,000= 47.5%.

How Do You Calculate Your Back-end DTI Ratio?

To calculate your back-end DTI ratio, you add up all of your monthly debt payments (do not include any expenses that are not listed on your credit report), which may include:

·      Your “house payment” or PITIA (this was used in calculating your front-end DTI)

·      Credit card payments

·      Automobile loan or lease payments

·      Alimony/child support

·      Educational/student loan payments

·      Any personal loans

·      Any other accounts reported in your credit reports

After adding all of these monthly debts up, you then take the total and divide it by your total gross monthly household income:

Monthly Debt Payments ÷ Gross Monthly Household Income= Back-end DTI Ratio

Examples

1)    Mr. Smith’s monthly debt payments come out to $1,700 ($1,100 for his monthly house payment, $300 for his car loan, and $300 for alimony). Mr. Smith is a carpenter and his gross monthly household income is $2,700. To figure out his back-end DTI ratio, Mr. Smith takes the amount of his monthly debt payments ($1,700) and divides it by the amount of his gross monthly household income ($2,700). Mr. Smith’s back-end DTI ratio is 62.9%, because $1,700 ÷ $2,700= 62.9%.

2)    Mr. and Mrs. Baker’s monthly debt payments come out to $2,300 ($1,900 for their monthly house payment, $200 for their car lease, and $200 in credit card payments). Mr. Baker is an electrician and his gross monthly income is $2,800. Mrs. Baker is a seamstress and her gross monthly income is $1,200. Combined, Mr. and Mrs. Baker’s gross monthly household income is $4,000. To figure out their back-end DTI ratio, the Bakers take the amount of their monthly debt payments ($2,300) and divide it by the amount of their gross monthly household income ($4,000). The Bakers’ back-end DTI ratio is 57.5%, because $2,300 ÷ $4,000= 57.5%.

3)    Ms. Garcia’s monthly debt payments come out to $1,600. Ms. Garcia is a civil engineer and her gross monthly income is $5,000. To figure out her back-end DTI ratio, Ms. Garcia takes the amount of her monthly debt payments ($1,600) and divides it by the amount of her gross monthly household income ($5,000). Ms. Garcia’s back-end DTI ratio is 32%, because $1,600 ÷ $5,000= 32%.

Why Do Your DTI Ratios Matter and What Should You Do?

Today, lenders have specific target ranges and limitations on allowable DTI ratios for loan modifications. Although your lender may have slightly differing DTI ratio targets and limitations, most lenders are willing to grant loan modification to homeowner’s whose DTI ratios are below 50%. Remember, lenders want to avoid risk and only want to extend loan modifications to homeowners who have a high probability of repaying their debts.

Therefore, it is a good idea for you to do your own initial front-end and back-end DTI calculations so that you can get a general sense of whether a lender is more likely or less likely to grant you a loan modification. When doing these calculations keep in mind that DTI ratios well below 50% are ideal. Doing these calculations can save you time in determining whether a loan modification is right for you or whether another option might be more advantageous to you in protecting your house.

As always, remember that the earlier you look into the requirements of loan modifications and begin the process, the better. Start by doing your own front-end and back-end DTI calculations and go from there. If you have questions, do not hesitate to ask for help. Also, remember that a qualified attorney who has experience in working with loan modifications can be extremely beneficial to you and can assist you in working directly with your lender and in protecting your interests.

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             For people experiencing severe financial difficulties and who are overwhelmed with debt, bankruptcy may be an important option. Whether difficult times are brought on by job loss, medical problems, family breakups, or even financial irresponsibility, bankruptcy can grant you much desired relief. Understanding some basic principles of consumer bankruptcy, however, is imperative in knowing which form of bankruptcy is appropriate.

Within bankruptcy law, there are several different “chapters.” Each “chapter” is specifically designed to help either individuals or businesses in eliminating, resolving, and/or repaying their debts. Selecting which bankruptcy chapter to proceed under, depends on the individual’s or business’s specific circumstances. For individuals (“consumers”) who are seeking relief through the bankruptcy process, two chapters are available: Chapter 7 and Chapter 13. These two bankruptcy chapters differ significantly and offer different results.

Chapter 7 Bankruptcy

             Chapter 7 is commonly referred to as “liquidation bankruptcy.” When an individual proceeds under Chapter 7, a trustee is appointed by the bankruptcy court. The trustee then gathers all of the individual’s property (except any property that is exempt), sells (“liquidates”) it, and distributes the proceeds of the sale to the individual’s creditors. At the end of this process, any outstanding debts are discharged (eliminated). The creditors then chalk-up their losses and move on, while the individual must start anew with very little assets leftover. The Chapter 7 process generally takes about four to six months.

             Not everyone is allowed to proceed under Chapter 7, however. To be eligible under Chapter 7, an individual must pass the “means test” (a mechanical formula that is used to determine who can and cannot repay some debt.) If it is determined by the court that the individual’s “current monthly income” is above a certain amount and the individual has the ability to repay some debt, the individual may be denied Chapter 7 relief and may be forced to proceed under Chapter 13. Most people who meet the eligibility requirements proceed under Chapter 7 because, unlike Chapter 13, Chapter 7 takes less time to complete and does not require the individual to pay back any portion of his or her debts.

Chapter 13 Bankruptcy

             Chapter 13 differs significantly from Chapter 7’s liquidation method. Commonly referred to as an “Adjustment of Debt” or “Wage Earner’s Plan,” Chapter 13 focuses on using the individual’s future earnings, rather than liquidated property, to pay creditors. When an individual files under Chapter 13, a court-approved plan allows the individual to keep all of his or her property, but the individual must pay a portion of all future income to the creditors. This payout plan lasts for three to five years, depending on the circumstances and the court-approved plan. When the individual has completed the agreed payout plan, any remaining obligations are discharged.

             Naturally, eligibility to proceed under Chapter 13 requires that an individual must prove that he or she is capable of paying a portion of his or her future monthly income to creditors for a period of three to five years. If the individual’s income is not regular or is too low, Chapter 13 may be denied. Likewise, if the individual’s total amount of debt is too high, the court may deny Chapter 13. Unlike Chapter 7, Chapter 13 takes much more time to complete. However, the major benefit of Chapter 13 is that the individual is allowed to keep his or her property.

             Understanding the main differences between Chapter 7 and Chapter 13 can assist you in knowing which form of bankruptcy will most likely work best for you. Keep in mind, however, that because the bankruptcy process is complex and oftentimes requires professional knowledge to be successful, seeking professional help is your best bet.

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           Although foreclosure filings across the nation were up almost eighteen percent last quarter compared to the same time last year, foreclosure rates in Seattle, Tacoma, and Bellevue were down nearly twelve percent from the same period a year ago. While this news may be refreshing, foreclosures continue to have adverse effects on property values throughout our community and on homeowners who have been striving to make their monthly mortgage payments in this tough economy.

             Many may wonder how foreclosures affect those homeowners who continue to pay their mortgages each month. In essence, foreclosures reduce a community’s home prices and have further unfavorable consequences on the economy as a whole. For example, in some studies, foreclosure on a home has been found to reduce the prices of nearby homes by as much as 9 percent—creating the potential that even borrowers who make every payment on their home mortgage suffer from foreclosures in their community[1]. Along with foreclosures, our slow economy’s sharp rise in unemployment has affected the real estate market and continues to affect many homeowners who are struggling to keep up on their mortgage payments.

To combat the grave effects that foreclosures and the economy are having on the real estate market, loan modifications have become increasingly popular among homeowners who are struggling to make their mortgage payments and who do not want to lose their homes. One of the biggest reforms to the current loan modification system has been President Obama’s Homeowner Affordability and Stability Plan (“HASP”), which was passed last March and was enacted to help qualified homeowners restructure and refinance their mortgages to avoid foreclosure. The HASP targets those homeowners with a “high combined mortgage debt compared to income,” or those who are “underwater” on the homes (those with a mortgage balance that is higher than the current market value of their homes).

Because a properly negotiated loan modification may allow a borrower to remain in his home and avoid foreclosure, loan modifications are becoming more and more appealing to many homeowners who need a little help to get through this difficult time. However, there are two important things to remember when considering a loan modification:                                          

1) Loan modifications are more likely to succeed if done early; and                                                                

2) Loan modifications are more likely to succeed if done with the assistance of an experienced attorney who has worked directly with lenders on loan modifications.  

Borrowers who have only missed a small number of payments or who have not yet missed a payment (but are likely to in the immediate future) are in the best position to have their loan modifications succeed. This is because the financial hardship of the homeowner is likely to have only recently begun and can likely be turned around with prudent planning. Similarly, the earlier the terms of the loan modification are negotiated, the more likely the homeowner will receive a better rate and can immediately begin to reap the benefits of the modification.  

Additionally, although loan modification requirements will vary from lender to lender, the documents needed to negotiate a loan modification are generally the same. These required documents may include, but are not limited to, your most recent tax return, a statement of your complete income, your recent pay stubs, and a written affidavit describing the hardship you are experiencing in meeting your financial obligations. Because loan modification requires many of these documents, the earlier you start, the more time you will have to gather these documents. Again, seeking help early on is very important, and, always remember, even if you are unsure about whether you qualify for a loan modification, it is better to ask earlier than later.  

Just as a loan modification is more likely to succeed if done early, so too is a loan modification more likely to succeed if done with the assistance of an experienced attorney who has worked directly with lenders. Seeking a loan modification is never an easy process. Besides the necessary documentation required in negotiating a loan modification, modifying a loan can be time-intensive and confusing. Often, you must work with a lender that is dealing with thousands of other homeowners who are attempting to save their homes through the loan modification process. The unfortunate result is that many homeowners are forced to wait for a substantial period of time before being helped, or they are left without any help altogether. With the assistance of an experienced attorney, however, many of these problems can be avoided and you can be represented by someone who has gone through the necessary steps. Again, being represented by someone with experience can be very beneficial.

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Although loan modifications have only recently become publicly known, in actuality they have always been a lesser known option for some borrowers. Not all loan modifications are equal. When President Obama’s Homeowner Affordability and Stability Plan first became available, the criteria seemed relatively clear: it had to be your primary residence, the payment could not be more than 31% of your gross income, you had to have a Fannie Mae or Freddy Mac loan, etc…However, the plan is not as limiting as once thought.

The most important thing to know about loan modifications is that they vary by lender. Some lenders have their own application packet, some are even available online, and others have no packet at all, leaving the borrower to gather and compile all documents necessary to apply. When the public first became aware of the plan, they sent in their paperwork to apply. Many never heard back from the lender or were told months later to resubmit the paperwork at it had become stale. The demand was overwhelming and the response time was slow. The entire program seemed extremely disorganized and most lenders had not even received official information or funding from the government yet.

However, the process now seems to be streamlining. The documents that are requested are generally the same no matter who the lender is. Typically, lenders require documents such as your 2008 tax return or a signed 4506-T IRS form, a hardship affidavit, and proof of income.

When loan modifications were first approved, borrowers immediately received their modification. However, lenders were finding that many borrowers would default under the modified plan, costing lenders millions in unnecessary administrative costs. To avoid such costs (which are ultimately passed on to the consumers), the vast majority of lenders are now giving borrowers a “trial modification.” In general, a trial modification is over the course of three or four months, and after that time, if the borrower has returned all required documents, signed the agreement, and made all trial modification payments timely, a permanent modification will be made.

There are pitfalls with loan modifications to also be aware of. First, once the documents are submitted to the lender, the borrower should check and then double check that the lender received the documents and that no documents are considered ‘missing.’ Second, some lenders have borrowers sending their trial modification payments to a special modification department as opposed to paying online or by check to the usual payment center. If a loan modification department has been established, sometimes there is no communication between that department and the customer service department, so all inquiries and payments should be directed to the loan modification department. Last, borrowers must understand that with each trial modification payment (which is usually at a much reduced amount than the normal mortgage payment) they are becoming further and further in arrears on their loan. They may receive collection letters, they may be reported delinquent on their credit report, and their online account may not reflect any payments having been made at all. This is normal. After the trial modification period has been successfully completed, the arrearage and late charges are tacked on to the end of the loan and future payments are reported as timely. However, if for some reason the borrower does not complete the trial or no longer qualifies (due to some change, i.e., income) the borrower is responsible for all of the arrearage and late fees, leaving some borrowers in a worse position than they were before the trial. So, it is important to know that there is some risk associated with applying for a loan modification.

I frequently hear from clients that their lender told them that they did not qualify for a modification because they were current. The borrower then purposely failed to pay for a couple of months in an attempt to qualify, only to be told that they are now in foreclosure. Some clients are told that they must be working to qualify. An attorney can help to maneuver through some of these complicated areas. Most importantly, seek help early on. The earlier you seek help, the more options that may be available to you. Seeking to save your home on the eve of a trustee’s sale is a nearly impossible task for even the most experienced attorney.

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The Obama legislation, which passed in March, aimed specifically to assist those in danger of losing their primary residence to foreclosure.  It was thought that individuals purchasing property for investment (namely those acquiring property then leasing it out) would not be eligible under the new law.

While that has not changed, our office has seen some interesting movement by banks and loan servicers regarding investment properties.  Under many circumstances, even the investor may gain some relief through loan modification.  

Banks/servicers largely follow the same pattern as the owner-occupied loan modifications.  First, they require a signed forbearance agreement, then they require an extensive disclosure of the investor's financial status in the form of a "Hardship Packet".  When they have those two things in hand, the servicer/bank will decide whether to modify the loan.  The following is what is most often required:

1.  Letter describing hardship

2.  Last two pay stubs

3.  Length of time at current employer

4.  One month's complete bank statement

5.  Most recent tax return

6.  Statement of your complete income (including family members residing with you)

7.  Proof of paid property taxes, homeowners insurance, and HOA fees

8.  (If self-employed): (a)  Profit/loss statements; (b)  three pay stubs; (c)  last two years tax returns; and (d)  business and personal bank statements.

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The US News and World Report online provides a dynamic breakdown of the basic components of the federally-backed loan modification program. 

According to the article, here are “Seven things you need to know” about a loan modification:

1. The plan focuses on payments made to lenders rather than the price of the loan.  Experts believe that even if the value of the home possesses little or no equity, if the modified loan payment is affordable, the homeowner will continue making payments.

2.  The plan would seek to reduce the mortgage payment to 31 percent of the borrower’s gross monthly income.  “To that end, the administration's plan requires participating loan servicers to reduce monthly payments to no more than 38 percent of the borrower's gross monthly income. The government would then chip in to bring payments down further, to no more than 31 percent of the borrower's monthly income. In lowering the payment, the servicer would first reduce the interest rate to as low as 2 percent. If that's not enough to hit the 31 percent threshold, they would then extend the terms of the loan to up to 40 years. If that's still not enough, the servicer would forebear loan principal at no interest.” 

3.  The plan would then encourage loan servicer participation by providing cash incentives:  “To encourage participation, servicers will be paid $1,000 for each modification and will get an additional $1,000 payout each year for as many as three years, as long as the borrower continues making payments. Borrowers, meanwhile, can get up to $1,000 knocked off the principal of their loan each year for as many as five years if they make their payments on time. Neither party can receive the cash incentives until the modified loan payments have been made for at least three months.”

4.  The plan would only apply to those under financial hardship.  Only owner-occupied residences with an outstanding balance of $729,750 or lower would be eligible.  (Sorry, no speculators.)

5.  The plan will require the loan modification to meet the net present value test.  What this means is that the lenders would compare the expected cash flow of the proposed modified loan with the expected cash flow of the loan unmodified.  If the modified loan would create more cash flow, then the loan will be modified and or restructured. 

6.  The plan will offer loan servicers with incentives to extinguish second liens like home equity lines of credit. 

7.  The plan may or may not work.  (Not the most satisfying conclusion, I know).  

Please refer to the full US News and World Report  article by Luke Mullins here. 

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The Homeowner Affordability and Stability Plan is a mortgage modification plan that is currently helping some homeowners lower their monthly mortgage payments.  Although eligibility is determined by your mortgage lender based on your financial situation and other guidelines, below are some of the plan’s features:   

The program is intended to help those who are current on their mortgage payments, but are unable to refinance because they owe more than their home’s current value.

• The program allows homeowners to modify their current loan into a 15 or 30 year fixed rate loan.
• The new first mortgage may not exceed 105% of the current market value of the home.
• The second mortgage holder must agree to remain in second position.
•  You must occupy the home as your primary residence.

 The biggest downside to this program is that you must have a Fannie Mae or Freddie Mac loan to qualify.    

In most cases you will need the following to apply:

• An application packet from your lender.
• Last two paycheck stubs.
• Last two years' tax returns
• Proof of financial hardship

 This program started on March 4, 2009.  There is no telling how long funds will last, so borrowers are encouraged to apply early.  

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