Owner’s Choices: Short Sale versus Loan Modification
Recent legislation encourages loan modification in an effort to decrease the number of foreclosures. If you are meeting with homeowners, see if one of their goals is to keep their home.
The new rules on loan modification provide relief for people who have had financial difficulty, but remained current on their payments. There are also some new programs for those in imminent danger of foreclosure, and those who are already up to 60 days late on their payments.
These programs are only for a family’s principal residence. It does not apply to second homes or investor owned properties. Loans that were originated before January 1, 2009 are eligible for modification.
Loan servicers will follow a series of steps specified in the programs to reduce the homeowners’ monthly payments in order to first bring the amount of the payments down to 38 percent of gross monthly income. As a second step, the government will share in the obligation to lower the payments even further to 31 percent of borrowers’ income. The first step in the process involves reducing the interest rate down to as low as two percent. Next, the term of the loan can be extended to up to 40 years. As a last resort, the principal of the loan can be reduced. The homeowner’s monthly payment includes principal, interest, taxes, insurance, flood insurance, homeowner?s association dues and/or condominium fees.
There is a payment to the loan servicer from the government to encourage the completion of this process. Also, if the borrower makes the mortgage payments on time for three years, there is a principal reduction payment by the government to the lender as a reward to the borrower for staying current on the financing.
To qualify, the borrower must still be employed and show the ability to make the payments after the adjustment. The loan can be well over the 80% of the value of the home that is required for refinancing. In fact the loan can be over 100% of the value of the home, so that people who want to keep their homes, even if it is worth less than the amount of the loan, can get their payments in line and stay in their home. The borrower gets only one loan modification, so it better be right the first time, because there will be no second time.
Loan servicers will use a net present value (NPV) test as a standard to judge each loan that is at risk of imminent default or is at least 60 days delinquent. The NPV test compares the net present value of cash flows with and without modification. If the test is positive ? meaning that the net present value of expected cash flow is greater with a modification ? the servicer must modify the loan. If the NPV test returns a negative result, loan modification is optional.
To see the Guidelines issued by the US Treasury, click here. For details on the Making Home Affordable Plan with all of its modification opportunities, click here. For all the details on the Financial Stability Plan that is part of this initiative, click here . Executives from Housing and Urban Development emphasized that access to the loan modification program is free and they warned homeowners to beware of rescue scams that claim to charge a fee for a government modification
For owners who have lost their jobs, this program will not work. If the owner needs to sell the home to move to another area, or if there are other personal issues such as divorce, these programs will not change the choice of pursuing a short sale. But for families who want to refinance out of a bad loan but have been prevented from doing so because the value of the home has fallen or the loan qualification requirements have become too severe, this new program should work well. In the next few weeks the loan servicers should be set up to review applications for loan modification.
For people who want to stay in their homes, this could be a godsend, if they qualify. There is no moving, no tax consequences, no effect on credit scores and no emotional trauma. For those who have to move, the short sale, deed in lieu of foreclosure or foreclosure itself are still the choices.