With millions of homeowners falling behind on their monthly payments, one in 6 underwater, and countless more struggling to keep up, politicians and banks alike are jumping on the loan modification bandwagon.
A modification -- or “mod,” as it’s known in the industry -- is simply the bank agreeing to change a borrower’s loan to make it more affordable. Mods usually result in a lower interest rate, principal forgiveness or some combination thereof.
For banks, adjusting loan terms is a way to keep cash coming in the door - even if it’s less than they’d been hoping for when they originally wrote the loan. For troubled borrowers, mods can provide an alternative to default and eventual foreclosure. It’s for these reasons that FDIC Chairman Sheila Bair and big banks like JPMorgan (JPM) and Bank of America (BAC) are aggressively promoting mods as the best way to fix the housing market.
The flood of troubled mortgages has also fostered a cottage industry that caters to distressed borrowers. Some are honest folks aiming to help struggling borrowers by using their mortgage expertise and contacts to negotiate better deals on behalf of their clients.
Others, however, are less upstanding.
According to Mandana Nejad, a real estate attorney and founder of Silver Lining Legal Group, a loan modification firm based in California, troubled borrowers have a lot to be wary of.
"Most loan modification companies are compromised of former lenders and brokers who put homeowners in these horrible loans in the first place," says Nejad. "Meanwhile, credit repair and debt consolidation firms are simply out to collect fees, regardless of whether or not they can actually successfully modify a loan."
Last year, the Bush administration formed HOPE NOW, a government-led effort to get banks and the loan servicers who collect payments on their behalf to step up loan-modification efforts. By most accounts, results were underwhelming, as HOPE NOW counselors often asked for too much, and banks gave too little.
Data show that mods done at the outset of the mortgage crisis ended up in default, despite the lower payments. Without proper screening criteria, mods simply delay the inevitable.
For a mod to work, lenders and borrowers must be able to find common ground. Falling home prices, job losses and massive fraud at the time of origination have exacerbated the challenge of finding new loan terms that make sense for both parties. To complicate matters, if a loan has been packaged into a security, loan servicers are obligated to follow predetermined modification standards set by myriad third-party investors.
Borrowers looking to handle modifications on their own face a maze of legal and bureaucratic complications - not to mention the stress of negotiating to save one’s own home. Nejad tells her clients that anyone can attempt to modify their loan themselves, but doing so requires knowledge of the best strategies for success.
Banks treat mods almost like a fresh loan. In order to get the best deal, borrowers must submit a complete application, write a compelling hardship letter, include verification of income, and often support the home’s current value with an appraisal.
While this is no easy task, troubled borrowers shouldn’t run out and answer the first debt consolidation or mortgage relief advertisement they hear on the radio.
Upstanding modification firms should offer:
- Money back guarantees with no exclusions
- At least one experienced attorney assigned to each case
- Direct access to the borrower’s lender(s)
- No more than a 50% charge up front
- Verifiable success stories, not just web testimonials
Still, successful mods require lenders to take losses. Armed with billions in bailout money, banks are now in a better position to allow their borrowers more affordable loans, even if it means more writedowns and less interest income going forward.
Time will be the true arbiter for the success of Bank of America and JPMorgan’s recent plans, but as pressure mounts to seriously curtail foreclosures, more and more federal money will be thrown at the problem. Other banks are likely to follow suit.
Wells Fargo (WFC) has yet to announce a plan of its own, but -- given its recent purchase of Wachovia (WB) and its inheritance of a massive portfolio of California option-ARMs -- we shouldn’t have to wait too much longer.
While mods are by no means the magic bullet many are searching for to fix the housing mess, they do offer a way for lenders to retain a cash-generating loan - and borrowers to keep their homes.
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