Clients often ask me if I will help them get a loan modification. I have done so on occasion, but generally recommend that clients try to obtain their own loan modifications. One of the main problems with trying to get a loan modification is that mortgage servicers were not offering much in the way of modifications until very recently. With the implementation of the Home Affordable Modification Program (HAMP), servicers now have some incentive to do workable loan modifications. The purpose of this article is to give an introduction to the HAMP program and some basic ideas of what needs to be done to obtain a loan modification.
The home must be a one to four-unit property and must be owner-occupied. For one unit, the principal balance on the first mortgage must be less than $729,750. There is no required loan to value ratio.
Debt to Income Ratios
HAMP uses a waterfall of modifications with the goal to get the mortgage payment to less than 41%, but not under 31% of the monthly gross income of the borrower. This is the Front End Debt to Income Ratio (“Front End DTI”). The mortgage payment, plus all other installment payments and debt payments must not equal more than 55% of the monthly gross income of the borrower. This is called the Back End Debt to Income Ratio (“Back End DTI”). If a borrower is over 55%, they are required to obtain HUD-approved counseling.
If the borrower is going through a hardship and that is the reason they are unable to make payments, special rules apply in favor of the borrower. A hardship might be a change in circumstances such as job loss or lower-income, or it might be an increase in payments (“payment shock”). If there is a hardship creating an imminent default (i.e., the borrower cannot or will not be able to make payments), the servicer is required to run a net present value (NPV) test.
The NPV Test must be run on each loan that is in imminent default or is at least 60 days delinquent. The NPV Test will compare the net present value of cash flows expected from a modification to the net present value of cash flows expected in the absence of modification. If the NPV of the modification scenario is greater, the NPV result will be deemed to be a positive result.
If the NPV Test is positive, the servicer is required to offer a HAMP modification. If it is negative, the servicer may, but is not required to, offer a HAMP modification. For more information on the NPV Test, please visit https://www.treasury.gov
Following are the steps that the servicer is to use in achieving the targeted Front End DTI:
- Step 1a: Request Monthly Gross Income as specified above.
- Step 1b: Validate total first-lien debt and monthly payments (PITIA). For purposes of making a provisional modification offer during the trial modification period, the borrower’s unverified income and debt payments can be used. Provisional information and modification terms will be verified in a timely manner.
- Step 2: Capitalize arrearage. Servicers may capitalize accrued interest, past-due real estate taxes and insurance premiums, delinquency charges paid to third parties in the ordinary course of servicing and not retained by the servicer, any required escrow advances already paid by the servicer and any required escrow advances by the servicer that are currently due and will be paid by the servicer during the Trial Period. Late fees are not capitalized.
- Step 3: Target a Front-End DTI of 31%. The lender/investor shall follow steps 4, 5, and 6 to reduce the borrower’s payment to the level corresponding to the Front-End DTI Target.
- Step 4: Reduce the interest rate to reach the Front-End DTI Target (subject to a floor of 2%). The note rate should be reduced in increments of 0.125% and should bring the monthly payment as close as possible to the Front-End DTI Target without going below 31%. If the resulting modified interest rate is at or above the Interest Rate Cap, this modified interest rate will be the new note rate for the remaining loan term. If the resulting modified interest rate is below the Interest Rate Cap, this modified interest rate will be in effect for the first five years, followed by annual increases of 1% (100 basis points) per year or such lesser amount as may be needed until the interest rate reaches the Interest Rate Cap, at which time it will be fixed for the remaining loan term.
- Step 5: If the Front-End DTI Target has not been reached, extend the term of the loan up to 40 years. If term extension is not permitted extend amortization. The 40-year term begins at the start of the modification (after the borrower successfully completes the Trial Period). Note that the servicer should only extend to a term that is necessary to reach the Front-End DTI Target; there is no requirement to extend to a 40-year term.
- Step 6: If the Front-End DTI Target has not been reached, forbear principal. If there is a principal forbearance amount, a balloon payment of that forbearance amount is due on the maturity date, upon the sale of the property, or upon payoff of the interest-bearing balance. If the modification does not pass the NPV Test and the servicer chooses to modify the loan, the modified balance must be no lower than the current property value.
If a loan modification is offered under HAMP, borrowers will have to complete a 90-day trial period at the modified rate. Borrowers will need to make all payments under the modified loan for this period of time. After successful completion of the program, the modification becomes effective.
Steps for Borrowers:
- Go to http://makinghomeaffordable.gov/. Click on the “Contact Your Mortgage Servicer” button to see if your servicer is participating in the HAMP Program.
- If your servicer is participating, go to their website and download their loan modification paperwork.
- Fill it out and fax it to the servicer. When filling it out, make sure to keep these thoughts in mind:
- You need to show a hardship so that the NPV Test is triggered. Describe what your decrease in income was or what your increase in payment was caused by.
- Your payment will probably be around 41% of your monthly gross income (MGI), so make sure your MGI is accurate.
- Call your servicer to verify that they have received your paperwork.
- Continue to follow up diligently with your servicer. I have had a few clients who have obtained loan modifications. All of them have diligently “bulldogged” the servicer to make sure the modification went through.
Modifications in Bankruptcy
In bankruptcy, it is important to remember a few things. First, a bankruptcy can significantly reduce your Back End DTI, which might allow you to qualify for a loan modification when you otherwise would not. Bankruptcy also might allow you to strip off a second deed of trust, which would help with the modification.
If you are in Chapter 11 or Chapter 13 bankruptcy, you will need to get court approval for the modification.