There are early reports surfacing that over half of loan modifications that were granted earlier this year are in default again, according to bank regulators. So the question that I was trained to ask when speaking with a loan modification prospect: “Can you afford your home – just not the loan that is on it?” should really be restated. That question leaves way too much to speculation as to a homes affordability. A $600,000 loan at 2% interest only (or “I.O.” using industry lingo), would yield a monthly payment of $1,000 – not including property taxes, mello roos, insurance, HOA dues, etc that would also constitute a total mortgage payment. Assuming the home’s value is equal to the loan amount, taxes in California would come to $625/month and insurance about $60/month (not including earthquake insurance, that is.) At this point, you’re looking at a minimum P.I.T.I. (principle, interest, taxes & insurance) payment of $1,685/month. That, however is NOT a basis to determine affordability.
A $600,000 fully amortized loan, at todays rate of roughly 5.5% would create a monthly payment of about $3,407. Your P.I.T.I. would then be $4,092. A few years ago, most people would argue that 5.5% is a terrific rate! Why, then is there is a huge disparity – in this case over $2,400/month – between the standard of affordability borrowers were brainwashed into believing and actual affordability? Lenders’ tried and true underwriting guidelines of no more than 34% – 38% of your gross monthly income going towards your mortgage expense was shattered with the abuse of the “Stated Income”, “EZ Doc”, “Limited Doc” or whatever else the option ARM loan was called. The lines of affordability were not only blurred, they were obliterated!
After about a year of trying to help out their borrowers, lenders are being forced to reconsider their strategy. Let’s face the truth. Yes, the lenders made an obsene amount of money during the Option ARM craze. Yes, the brokers misrepresented the wonderful attributes of the Option ARM loan and conveniently forgot to explain the downside. And, Yes, actual numbers were stretched in the loan application process to ensure approval. These are all truths that burn like “The Scarlet Letter” on the collective chest of the lenders. But the home buyer must also accept responsibility for their part of the process – namely looking away when all this was happening around them. I’ve spoken to many loan modification clients who were so ready to scream “FRAUD!” – to which I had to reply, “but wasn’t that YOUR signature on the loan application (and specifically your initials at the bottom of the income and assets page which proves you reviewed this particular page) that stated you made $6,500 a month as a waiter in a Beverly Hills restaurant?” Boy! those must’ve been some great tips that neither had to be proven to the underwriter nor reported to the IRS.
Now what we are noticing, is that many lenders are requiring a “payment plan” period of usually 4-6 months, to determine that the homeowner is serious about keeping their home – and not just trying to work the system. The plan usually consists of bringing in 20% – 30% of the amount in arrears (if you are more than 7 or 8 months down) or at least one payment if you just entered N.O.D. (Notice of Default) status to show good faith; and a monthly payment to be negotiated – which hopefully would make sense and be lower than the payment that put you into default to begin with. If the plan is adhered to, then and only then will the lender consider paying their legal and administrative fees to permanently modifying the loan. Also good to know, is that many times, what a lender will do for one borrower they will not do for the next. “Prior performance does not guarantee future results” is the phrase I find myself saying to every loan modification client I deal with. One of the reasons for this is that most lenders deal with several investors – and it’s usually the investor that determines the fate of the borrower. So if you are in the market to modify your loan, don’t be surprised if the lender, or their investor, want to see cash up-front to even consider helping you out.