Introduction. After three years of counseling folks in the throes of making a distressed housing decision, I have to honestly ask myself if loan modification today is a prudent, wise, or productive endeavor. Regrettably, in most – though not all – cases, the answer is an emphatic “No.” Of the many consumer advocates, attorneys, and counselors out there, I may be in the minority. But I suspect that of the many consumers who have gone through the modification process, I am in the majority.
Let me explain. Assume you had never sought a loan modification yourself. Assume also, that a person came to you complaining that they had been seeking a loan modification through their lender[1] for the past eight months, and were no closer to a resolution than the day they started. They tell you that they were passed from “single point of contact” to “single point of contact” multiple times, and were always getting contradictory information, bordering on the run-around. Documents were lost; had to be updated; new documents, never-before requested, were required at the last minute; and the goal posts were seemingly moved farther away, the closer the homeowner got to scoring a loan mod. They could never get any definitive information from the lender’s negotiator, and never knew when, if, or how, a modification would ever occur.[2]
Having heard this for the first time, one might nod their head sympathetically, listen politely, and assume that the teller of the story was exaggerating this tale for dramatic affect. Say, however, you later heard the same story from another person who knew nothing of the earlier saga. “Coincidence” might be a reasonable reaction. But what if you heard this description of the loan modification process time after time after time? All from rational adults who spoke convincingly, sometimes through tears, as if reciting events from the same bad script.
The term for this experience is “Kafkaesque,” which refers to the stories by the Czech author, Franz Kafka [1883-1924]. The simile is defined as “…of, relating to, or suggestive of Franz Kafka or his writings; especially having a nightmarishly complex, bizarre, or illogical quality. E.g. Kafkaesque bureaucratic delays”. “Nightmarish”, “bizarre” and “illogical” – all apt adjectives for the loan modification process.
Loan Modification – A Brief History. There are two basic categories of loan mods:
- Government Sponsored Mods. The primary one is Home Affordable Modification Program, or “HAMP.” This is the 2010 government program that was initially touted as intended to help save the homes of three to four million Americans suffering some form of distressed housing hardship. [Keep in mind that ´negative equity` is not, in banker-speak, a “hardship”, and will not, on its own, ever qualify a distressed borrower for any type of foreclosure avoidance relief.] The objective of the program was to modify borrowers’ loan terms so they could afford their monthly payments, which might have increased due to adjusting interest rates or simply because they bit off more than they could chew.[3] In the beginning, there was no such thing as “principal reduction”, so the best one could hope for was to add the unpaid sums, past due principal and interest, to the back end of the loan – and perhaps extend its term from 30 to 40 years at a more affordable interest rate.[4] The program’s telephone number, 888-995-HOPE, epitomized the product our government was selling.[5] The truth is that HAMP has been an unmitigated failure, not only in the paltry number of successful mods, but also in the amount of servicer abuse of the programs.[6] For a revealing expose’ of this issue, a 2011 ProPublica article is insightful.
- Proprietary Loan Modifications. This is the catch-all term used to identify all of the various and sundry lender programs that the individual banks and servicers have devised. Since each bank is different, there really is no published template they must follow. Typical descriptions of a lender’s proprietary loan mod program are kept intentionally vague. Implementation of these programs invariably depends on who one talks to. Securing a reliable description is like trying to nail Jell-O to the wall. The best one can learn about a lender’s private loan mod program is what they publish online. And very little information is there, other than, of course, the patronizing phrases, “We Care,” or “We’re Here to Help.”
Re-Default Risk. It is very hard to get accurate numbers on this. A 2009 Housing Wire article reported that it was as high as 70%. In 2012, American Banker claimed it was 60% within 18 months. The thing to emphasize, in addition to this remarkably dismal record, is the fact that the folks who failed, also lost a year or two of their lives trying unsuccessfully to remain in their home. Meantime, all the while, they are being reported to the credit scoring agencies as making only partial payments. Many distressed borrowers do not realize this.
The Need to be in Default. Regardless of what some “authorities” may say, invariably, most borrowers are told by lenders that to qualify for a loan modification, they must first be in default, usually at least three months. But this does not mean that once they go into default they are assured of getting their loan modified. No – it means that until they are in default, they cannot even stand in the loan mod wannabe queue. Then, after going into default and playing the shell game called “loan modification,” many are unceremoniously denied via a letter offering little or no explanation. In many cases, borrowers are summarily told that they did not supply the necessary documents in time, or simply that they “don’t qualify.” What does this really mean to the distressed borrower, who did everything the lender told them to do? It means that if they were struggling before, they’re really in trouble now, since after the turn-down, they usually cannot pull out of the tailspin of default; and because of the drop in their credit rating for months of nonpayment – per their lender’s instructions – they have no means of borrowing the necessary funds to cure the default or refinance their home.
The Failure Ingredient. The HAMP program, just like HARP, HAFA, and the entire alphabet soup of federal programs has a fatal flaw: Lender participation is voluntary.
Riddle me this, Batman: If participation means the Big Banks must follow government rules, why would they agree to help?
- Because they enjoy the feds telling them what to do?
- Because they truly want to help Beleaguered Borrowers?
- Because inside these soulless institutional zombies beats a heart of gold?
If you believe that, let me sell you a very rare and exclusive membership in the Lance Armstrong Fan Club. But wait! There’s more! We’ll even throw in Fleetwood Mac’s hit song, “Little Lies.”
Legal and Practical Issues to Consider. Loan mods are not for everyone. Before undertaking a trek as arduous as seeking the elusive Golden Fleece, homeowners must breathe deep, disassociate from the emotion and anger, and focus on Numero Uno. Additionally, they must Look Forward – Not Back. What is best for the borrower, their family, children, retirement, and mental health going forward? Here are some of the important factors in deciding whether to get aboard, or stay aboard, the slow moving modification train.
1. Realistically, what are your chances of actually being approved? Have you applied before and been turned down? Have your circumstances materially changed from the last time you were denied? If not, chances are that you will find yourself in an endless loop, like Bill Murray in Groundhog Day. It may be time to move on. If you doubt me, look at the numbers; and of those approved, what is the rate of re-default?
2. What are your debt-to-income ratios? Both “front end ratios” [monthly loan costs (“PITI”) plus HOAs compared to gross income] and “back end ratios” [total household costs compared to gross income]? These are part of the HAMP calculation for approving permanent loan mods. For a discussion of these ratios, go to the link here.
3. How much time do you have going forward? Other than modification, the only other alternatives to a distressed housing situation, such as huge negative equity, is disposing of your home and your loan, via a (1) short sale, (2) deed-in-lieu of foreclosure, or (3) foreclosure. Timing is very important today. If you don’t get a modification, there could be dire tax consequences. The Mortgage Forgiveness Debt Relief Act provides protection against the imposition of an income tax for cancelled debt if any of these three events occur this year. [7] However, it is set to expire at the end of 2013. And as we saw last year, when it was set to expire on December 31, 2012, our dysfunctional, dithering, and duplicitous Congress did not get around to granting an extension until the start of 2013. You can be sure that many homeowners were biting their nails over the Christmas Holidays, hoping to hear word that the law would be extended. We have no idea whether a last-minute extension will occur again in 2013, so prudence demands that we assume there will be no extension, and proceed accordingly.
4. If you are current on your loan, or only recently stopped making payments, and your lender is one of the Big Banks or servicers, it is likely that a foreclosure will not be completed [i.e. filed, served, judgment taken and property auctioned] in 2013. This means that if you want to complete the process this year, a short sale is your most likely option today, since lenders typically will not consent to a deed-in-lieu without requiring that you first try and fail to short sell the property.
5. How important is your credit rating? If you’ve already stopped making your loan payments, or been in and out of prior unsuccessful modification attempts, your score may already be damaged. But one thing is clear: You cannot improve your credit score until you complete a foreclosure, short sale or deed-in-lieu of foreclosure. In other words, as long as the bank is reporting missed payments, you will continue to suffer a drop in your rating, regardless of the fact that all of your other consumer debt is paid on time. All three of these events will likely result in the bank’s issuance of a 1099-C. You want that event to occur in 2013, to be safe from the imposition of an income tax on the “cancelled debt” – i.e., the remainder of your loan that the bank did not recover. Of course, if you’re positive the bank will permit you to modify, then perhaps you can roll the dice and go down that path. But just remember Murphy’s Law. Or in the immortal words of Clint Eastwood, “Do you feel lucky?”
6. How’s your emotional health? Do you have the appetite for going through the frustration, dissembling, lost paperwork, more lost paperwork, and any one of a number of other excuses the Big Banks have devised for turning the loan mod process into a Kafkaesque, surreal, and humiliating exercise? To put a finer point on this, when was the last time you heard a distressed homeowner say “That loan modification process was just wonderful! The people were so efficient and friendly! Why, I’d recommend it for anyone suffering from negative equity.”?
7. Remember – for the time being – most Big Banks still dual track their borrowers seeking help, so requesting modification will not result in keeping a foreclosure at bay.
A Glimmer of Hope. There is one glimmer of hope that will likely emerge later this year. There is a new bill in the Oregon Legislature that will require non-exempt banks and servicers to mediate as a part of the judicial foreclosure process. Last year they were required to offer mediation if requested, in all non-judicial foreclosures. However, between that law (SB 1552), and the Niday ruling from the Oregon Court of Appeals – both of which occurred in July 2012 – the banks decided that they would prefer the self-inflicted wound of going into court – with the attendant costs and delays – than look Beleaguered Borrowers in the eye, mana a mano, and come up with an effective foreclosure avoidance solution. This is the same reason that executioners wear hoods – so they can trade in accountability for anonymity.
So later this year, it is hoped that all borrowers facing foreclosure will be able to partake of mediation, and the banks will, for once, have to decide whether they really want to help those seeking an alternative to foreclosure. If and when the law passes, we may – for the first time – see what the banks are made of. They can either roll up their sleeves and work with their borrowers – i.e. creating solutions that keep them in the home, or offering alternatives that allow them to leave with dignity – or they can treat the loan modification with the same disdain as in the past. Time will tell. Like 2012 before it, 2013 should be an interesting year.
[1] I am using the word “lender” to mean either the entity owning the loan or the servicer, acting as the agent for the owner of the loan, who has direct contact with the borrower.
[2] The loan mod process roughly resembles the scene in Princess Bride, where Westley is slowly tortured in The Machine, and then calmly asked by The Six Fingered Man, how he feels.
[3] During the easy-money era, circa 2004-2007/8, “biting off more than one could chew” was a propensity of many Americans, who, wanting to partake in the American Dream, entered the real estate market with the belief that values would always increase. If a loan became unbearably burdensome, the homeowner could extricate themselves from it by selling the home for a profit. Not a bad gamble, huh? Both the banks that served up this tripe, and borrowers who bit, were wrong. Recent history has told us that once the Ponzi Scheme formerly known as “securitization” collapsed under its own weight, real estate values imploded, and neither refinancing nor selling became an option, due to negative equity.
[4] The effect, of course, was that the lenders earned interest on interest. And when, much later, some lenders did grant principal reductions, it was done in such a haphazard and ad hoc manner, as to defy any rational prediction as to who would qualify, and who would not.
[5] A related federal program, HARP, was designed to allow borrowers to refinance their homes, even though they had negative equity, i.e. the current loan was greater than its appraised value.
[7] Caution: There are certain limitations. You must have resided in the home for two of the last five years, and used the borrowed funds to build, buy, or substantially improve the home. Check with your CPA or tax professional.
