The Set-up
When it comes to avoiding foreclosure, government backed loan modifications seem to be the first choice for many homeowners. Without a doubt there is a place in the market for reasonable loan mods. Personal attachment to your home with its unique location, features and memories has real value and does need to be considered. While this is a decision that only you can make, what we can do is help you determine the actual cost of the modification and its long term effects, so that you can figure out what’s best for you and your family.
To fully understand the situation we need to take you behind the curtain to see what the bank is doing and why they’re doing it. When lenders evaluate you for a loan modification, they all go through a similar process. After every other requirement is met, there is one final test that must be passed before a loan mod is granted. This final test is called the NPV test. NPV stands for Net Present Value. To put it simply, the bank will not agree to any modification of the loan until it conducts a complex mathematical calculation that tells them whether they stand to get more money through foreclosure or through the loan mod.
No matter what the terms of the modification are, the simple fact that the bank has approved it means that you would be giving them substantially more than they could get through foreclosure and resale. While you may think of a loan mod as a way to save your home, the banks actually design them, not to keep you in your home, but to keep you in your loan. This doesn’t automatically mean modification is the wrong thing for you. But before you obligate yourself, you deserve to know what all of the costs will be. Once you know exactly what the cost is, you can decide whether or not you want to pay it or whether another alternative might work out better. While modifications make a lot of sense for some, for others they can be a recipe for disaster.
The Scenario
To illustrate the point let’s look at the hypothetical case of Mr. and Mrs. Dee Stressed Homeowner. The Homeowners purchased their dream home in Dec. of 2007. They had to stretch, but with the help of their mortgage company they got the house they really wanted. It may have been more than they needed but with the 3 year interest only ARM program their Lender advertised, they could actually make it work. At the time, their idea of a worst case scenario was that with Utah homes appreciating at a rate of 17.6% per year*, if they couldn’t afford the payment when it reset in Jan. 2011 they could always refinance or just sell for a profit. At the current rate of appreciation the $300,000 home should be worth nearly $488,000 by the end of the three years. This was clearly a “No Brainer”.
It appears that what was a, “No Brainer” in 2007 turns out to be a, “No Brainer” of a different kind in 2011. That $300,000 home today is now worth just over $200,000*. If the market stabilizes by late 2012 as expected, their home value should then bottom out at about $180,000*. Prices are then expected to remain flat for a year or so before returning to their traditional 4.4% yearly inflationary bump.
Mr. and Mrs. Homeowner however still love their home and have grown very comfortable in their neighborhood. So, being completely oblivious to the numbers, they decide to put all of their spare time, resources and energy into obtaining a loan modification. When their house payment reset in Jan. it went from around $2,050 to about $2,700. This may not seem like that much but with their income already suffering because of the economy it was the last straw. By the time they got the Notice of Default in April, their loan balance with missed payments, penalties and fees, had gone up from $291,000 to $304,000 and the bank was demanding payment in full.
The Deal
Mr. and Mrs. Homeowner didn’t let themselves get distracted by the math but went right to work and being extremely diligent, submitted all of the required documentation in a timely manner. All of their hard work and patience paid off and a short 112 days later they received the good news that they had been approved for a loan mod. The new loan balance with all of the added costs was now up to about $319,000 but what mattered most was that the new payment at around $2,000 once again seemed possible. This was surely a win for everyone. The bank avoided a big loss and the Homeowners got to keep their home. Once again a true “No Brainer”.
Although the story seems to have found its way to a happy ending, the tale isn’t quite over. Jumping forward five years we find the Homeowners at the end of their modification period. The payment is now $2,900 because of the increased loan balance. The house is now worth $196,000 and they currently owe $319,000. Mr. and Mrs. Homeowner are back to the exact point they started at when they missed that first payment, except they now owe $28,000 more on a house that is worth about $4,000 less and their payments are $200 higher. The formerly tickled Homeowners are still underwater by $123,000 and they still can’t make the $2,900 payment.
As distressed homeowners we’re thinking that all we need is a way to bridge from here to there. The market will return and we’ll be fine. When we think modification, what we’re hoping for is a bridge. A bridge is normally built to get from one place to another, over an obstacle that blocks ones path. The obstacle from the homeowner’s perspective is a payment they cannot make, made impossible to get around by negative equity and damaged credit. They hope the bridge will take them to a better future. A future where the economy is great, home prices have rebounded and all the troubles are a distant memory. The hard truth is the fact that the bridge doesn’t actually go anywhere. Instead it brings you back to the same place you were at 5 years earlier, but with less gas. Lest we forget, the banks built this bridge to protect themselves from the market downturn their own policies helped to create.
The Reality
One reason the modification is a bridge to nowhere is the fact that the market cannot be counted on to save anyone anytime soon. Utah in the last year posted the 5th largest decline in home values in the entire nation at 9.8%*. This year as a result of the 5 year interest only ARMs that were originated in 2006 coming due for reset we expect an increase in foreclosures. This will likely add fuel to the market declines which are now predicted to be as high as 11% for 2011*. The significance of this is the fact that when it comes to the average loan modification, there is no reduction of principle; because government backed lenders like Fannie Mae, Freddie Mac, FHA and VA don’t allow it. These continuing market declines only add to the already severe negative equity, bringing more homeowners into foreclosure and making a bad situation even worse.
The reality is, when the bank offers you a modification they are asking you to repurchase the home you are already in, under terms that you would never have accepted when you first bought it. This time around you are asked to pay an average of 32.8% more than the home is worth in today’s market*. The bank doesn’t want to lose any of their money so they’re adding the thousands of dollars in penalties, attorneys’ fees and interest charges to the balance. To top things off the modified terms will expire in five years leaving you stuck with payments you already know you can’t make and a loan balance that makes it impossible to refinance.
There is really no point talking about the incredibly low loan mod approval ratios (2 out of 10) because homeowners are not winning this one. There is also no use worrying about astronomical re-default rates when at the end of the 5 year modification, unless they extend, (which no homeowner should ever do), the default rate will likely be close to 100%. The bottom line here is the fact that modifications are not fixing anything. All they do is push the problem off to another day while things continue to get worse. One thing you can count on however is that the banks and their lobbyists are busy right now cooking up the next batch of foreclosure remedies and conjuring up a way to make it sound like a public service. Instead of “Hope Now” they should call it “Still Hoping”.
Continue reading for the shocking conclusion at the Short Sale Solution
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