Loan Modifications Blocked by Bad Home Equity Loans?

Loan Modifications, touted as one solution to the housing crisis, haven’t lived up to their promise. For one thing, they seem quite difficult to get. A cbsnews article suggests this is because of potential problems with the banks’ balance sheet causing by lurking bad home equity loans. The theory goes, if the banks recognized the true value of these loans, the writedowns to their balance sheets would be in the billions, causing losses and a possible need to increase the amount of regulatory capital they have on hand. For those of you that have been following the financial crisis, you’ll know there has been efforts to force the banks to increase the amount of cash they have to offset the amount of money they have lent out in loans. This is what is meant by regulatory capital.

The article shows a Reuters image I’ve captured here.

Bank exposure to unsecured home equity loans

This raised some questions in my mind.

• Why is this impacting requested loan modifications where there is no second lien present? I can understand the reluctance to modify the second lien so that it loses most of it’s value, but I don’t think this explain the many loan modifications that are not getting through as there is no second lien or home equity loan.
• What the heck is a “unsecured home equity loan”? A home equity loan by definition is secured by real estate. Otherwise it is just a personal loan. So I did some research. Apparently, a home equity loan becomes “unsecured” when the there is no equity to support it (it’s an underwater loan). If this is the explanation I think the “40% writedown” may be too conservative. In distress situations, the second lien is usually wiped out almost completely.

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Bank of America Offers Principal Reductions

The Obama administration has not been happy with the lenders’ effort to help property owners in the housing crisis. For the more than 6.5 million property owners currently late on their mortgage only 170,000 loan modifications have been completed.

Under increasing government pressure, Bank Of America launched a new program to erase as much as 30% off the principal in underwater home loans. The program should be available sometime in May, and before you ask, yes it is only available to homeowners with principal residences.

The enhancements to the National Homeownership Retention Program (as they call it) are coming soon according to their web site.

Bank of America has not been my favorite bank, but I am cheered to see a major bank lead the way towards measures that must be taken. Both property owners and the banks are going to have to compromise and meet somewhere in the middle for us to get out of this mess.

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Do Forensic Loan Audits Work?

Forensic Loan Audits is another tool underwater and delinquent borrowers are using to fight foreclosure. The idea is that you find problems with the mortgage documentation and use this to pressure the lenders into a loan modification or other outcome favorable to you the borrower.

During the height of the housing boom, not only did lenders get careless with who they would lend to, but also with following the RESPA and TILA regulations. RESPA, Real Estate Settlement Procedures Act, mandates improved disclosures (and timelines for those disclosures) for real estate transactions, such as the good faith estimate of closing costs and the HUD statement. The serving transfer notice you get when your bank sells your loan to another is part of RESPA. TILA, the Truth in Lending Act, governs disclosures about the cost of credit, such as the APR (annual percentage rate).

A forensic loan audit may find violations of RESPA and TILA. However an recent article by Marilyn Bowden is finding that even though 98% of loan audits find violations, it doesn’t buy you much. For one thing pursuing this with your lender is a legal matter with all the costs that come with that, including litigation. Another is that the lenders are not really responding to the legal pressure. Think about it, you are in a long line of people threatening to sue the bank.

However, comments on the web indicate some success when the bank can’t produce the mortgage documentation at all. With the dicing and repackaging (securitization) of mortgages done for the now hapless investors, some mortgages may have gotten lost and that might be something worth hiring a lawyer for.

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loan modifications, alternative to foreclosure

Loan modifications are becoming a popular alternative to foreclosure.  A loan modification, sometimes called a workout, is where the lender changes the terms of the loan, such as the interest rate, the amortization type, or even the principal balance (dropping  the principal balance is still not common but it does happen). The idea is by changing the terms of the loan to lower the payments the borrower can continue to make payments on the loan and prevents loan from becoming non performing.

Here’s what I have heard so far on loan modifications:

• They are not working with investors
• They won’t talk to you unless you are behind on your payments
• The customer service folks won’t help you, you have to talk to the actual decision makers

Of course this is all hearsay.  However I do believe there is some truth to the buzz I’m hearing.  Navigating the bank hierarchy to get agreement on a loan modification is hard.  That is why there are a number of companies that will help you do just that.

According, to the Loan Modification Handbook the first step is to draw up a hardship letter and a budget. What can you afford? And why do you need a loan modification? Banks are numbers businesses and if you can show them that the new numbers make sense you might have a good chance of getting a loan modification.

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Loan modification handbook

In dealing with a toxic mortgage you can no longer carry, so far I have identified three options:

• Stop making payments and let the bank foreclose on you.
• Find a buyer and negotiate a short sale with the bank
• Keep the property and get a loan modification

I’ve written about short sales previously in this blog.  The foreclosure option is the option of last resort.   Although I have no emotional attachment to the properties it appears the least harmful thing I can do to my credit is to try and negotiate a loan modification as a first step.  If that didn’t work I could look into a short sale or simply give the deed back to the lender.  This is called a “deed in lieu of foreclosure” and not quite the same as a foreclosure.

I belong to a few real estate mailing lists.  One poster to the group, claimed she was able to negotiate a loan modification that cut down on her payments and knocked $46K off the principal balance.  That sounded pretty good to me, so purchased the book she recommended: The Loan Modification Handbook

Written by Michael Albert and Rami Ibrahim, it arrived from Amazon a few days ago.  The Loan Modification Pamphlet would have been a better name for it.   So at first I was rather disappointed at the rather slim size for the price.  However it is a good introduction to the topic.  It provides examples of letters you write to the lender and good advice on how to get to the right decision maker (hint: it’s not the person that answers the customer service line).  A nice touch was a listing of the actual phone numbers for many banks’ loss mitigation departments.  That alone is quite useful, as anyone knows from navigating a large corporate bureaucracy by phone.

So far I haven’t acted on any of the steps in the book, but I will soon.   I read somewhere that a loan modification is 40% cheaper for a bank than a foreclosure.  For one of my houses in particular, the area is gutted with foreclosures and nothing is selling, if the lender has any sense at all they should be willing to work with me.

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Smart loan modification strategy from WAMU

I had an 5 year ARM on a duplex whose fixed interest rate was about to expire.   As I previously written it was a dilemma.  Refinance and increase my already negative cash flow by hundreds of dollars.   There are no investor loans out there for 5.6% (my current rate).   Or try to sell in a down market.  Since my real estate broker said there was investor activity, I listed.  However my listing hit the market literally hours before the Humboldt fire which almost wiped out the town of Paradise.  A last minute wind shift spared most of Paradise but the fledging real estate activity was snuffed out.

So I then spent some time reading through the note trying to understand what would happen in a few months.   It was confusing so I called my lender, WAMU, they had been sending me letters about the reset anyway.

The bad news?  Once the ARM expired,  the interest rate would be recalculated every month. If it had been once a year, I could have taken my chances and re-evaluated the situation next year as the margin would have kept the rate around 6%. Although interest rates are not moving up very quickly right now, in time, inflation will push them up, so a significant risk.

The good news?  They offered me a loan modification.  And get this, I did not have to qualify for it.    The deal was a 7% 5 year fixed rate with interest only payments.  Since my current 5.6% loan was fully amortized, my payments would actually go down by $50.  I took the deal.

Is a good deal?  Well it’s really not a great deal.  I would stop making progress at paying down the principal.  And I would be paying quite a bit more in interest.  So the numbers are not great.  However for my current situation, it was a good enough deal.  Here’s why:

I didn’t have to qualify.  While my FICO is good, my debt to income ratio is not the best and I have more than four properties.  Some of you might not know this, but borrowers with more than four properties are having problems getting any loans at all.   I recently talked to a big time investor that has hundreds of properties.  His financials are pretty good, but no one will give him a loan, he has to pay cash.

5 years of breathing room. The property is essentially break even, and with this deal it will stay break even.  The extra $50 a month cashflow will cover the  loan modification fee in a year.

I keep the HELOC that sits behind this loan. I have a second lien on this property that is a HELOC, there is a balance that would need to be paid off with any refinance or sale.   The property isn’t underwater but in this market paying off the first and second liens when selling would leave very little profit likely to be eaten up by the transaction fees.   Also keeping the HELOC is a nice bonus as it is a possible emergency cash source for me.  It helps me sleep a bit better at night.

Since WAMU is making better money on the increased interest rate, it’s a good deal for them.  And by offering this deal they prevent a possible foreclosure and have a performing loan on their books.  I believe WAMU is yet another lender that has been slammed by foreclosures and the subprime debacle.  So it’s a win win for every one.  I wonder how many banks are adopting this strategy.

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