Beyond the Loan Modification: Options for Distressed Homeowners

Talk radio airwaves are inundated with ads peddling loan modifications as a panacea for mortgage woes. While loan modifications may be appropriate for some, loan modifications are in fact merely one of many ways a distressed homeowner may find relief. Moreover, loan modifications may be one of the more difficult and least successful tools a borrower can use to obtain relief.

Generally, loan modifications are appropriate when a borrower has faced long-term changes in income. If the borrower can make payments on an existing loan, but finds himself behind in payments and doesn’t have enough money to bring the account current, a loan modification is a good option. In some instances, a loan modification might also be appropriate when a borrower can't afford the current payment, but has a steady source of income that insures an adjustment to the loan will not be in vein. In such instances, a lender may agree to change the terms of the original loan to make the payments more affordable. In such instances, a loan could be permanently changed in one or more of the following ways: (A) adding the missed payments to the existing loan balance; (b) changing the interest rate, including making an adjustable rate into a fixed rate; or (c) extending the number of years you have to repay.

Lenders will often tack on fees associated with servicing the loan modification in a loan modification. Lenders may also demand an up front payment of between 5 and 50% of the arrears. With loan modification agencies charging fees up to $3,000 before it is clear what kind of deal a lender may demand, a borrower may pay $3,000 for a loan modification and not have enough cash left over to meet the lender’s demand.

Lenders are often reluctant to agree to loan modifications because such deals often mean lenders must agree to permanently reduced payments, basically resulting in a drop in revenues for the lender.

Rather than leaping blindly into a $3,000 loan modification negotiation that may not be successful, a borrow might want to explore other options, such as a partial claim.

If a mortgage is insured, a lender might help a borrower get a one-time interest-free loan from the mortgage guarantor to bring the account current. A borrower may be allowed to wait several years before repaying this loan. To qualify for a partial claim loan, a borrower’s loan must be between 4 and 12 months delinquent, and the borrower must be able to begin making full mortgage payments again. If the borrower qualifies, HUD will pay the borrower’s lender the amount necessary to bring the mortgage current. The borrower must sign a promissory note, and a lien will be placed on the borrower’s property until the promissory note is paid in full.

Another option to a loan modification is reinstatement. Lenders are always willing to discuss accepting the total amount owed in a lump sum by a specific date. Borrowers should explore this option before considering a loan modification because negotiations are usually straightforward and lenders typically require nothing more than the missed payments and late fees.

Forbearance is another possibility. With forbearance, the lender may allow a reduction or suspension of payments for a short period of time and then agree to another option to bring the loan current. A forbearance option is often combined with a reinstatement when the borrower knows she will have enough money to bring the account current at a specific time. Again, these negotiations are pretty straightforward and typically easy to settle because the lender is merely postponing payments rather than losing payments altogether.

A borrower will also want to consider obtaining a repayment plan. With a repayment plan, a lender may agree to allow the borrower to resume making regular monthly payments, plus a portion of the past due payments each month until the borrower is caught up.

Often, especially when a borrower is severely behind in payments, lenders may be hostile to the idea of a loan modification, particularly because the modification means the lender must reduce the interest rate or write off a portion of the principle. In such instances, a loan modification agency will not be able to adequately represent a borrower, and the borrower will need to confer with a litigation attorney familiar with foreclosure defense, unlawful detainer, and landlord tenant law.