Underwater On Your Home Option 3: Get a Loan Modification

In this series, I detail six possible ways to deal with an “underwater” home—one that’s worth less than the amount of money owed on it. Here is part three of my six-part series.

When Javier Gonzales first started falling behind, he doggedly pursued a loan modification. He had both a first and second mortgage with the same lender, both at high interest rates. After seven months of sheer frustration—unreturned phone calls, paperwork that was sent to him on legal paper and therefore couldn’t be faxed back as required, and lost documentation—he finally got an offer that the lender told him would expire at five p.m. the same day he learned about it. It only covered one of the loans, and only fixed the rate for three years. Still, he signed the paperwork and overnighted a $500 processing fee to the lender.

Option #3: Home Loan Modification

When homeowners realize they are in over their heads on their home loans, many ask their lenders to modify their loans. With most loan modifications, lenders lower the interest rate and payment, either temporarily or permanently. It is also fairly common for lenders to extend the term of the loan or to allow borrowers to make up missed payments by tacking them onto the end of the loan or spreading them out over the remaining loan. Fewer than 3% of loan modifications overall involve principal reductions, though, according to data published by the Office of the Comptroller of the Currency. A recent New York Times article said that Bank of America and Chase are quietly modifying some their most risky loans—“option ARMs” that allow borrowers to pick payments so low that they can go deeper into debt even if they make their monthly payments on time—before borrowers default, and in some cases slashing the balance. But that seems to be the exception, not the rule.

The most well-known modification program is the government-initiated Home Affordable Modification Program. The Treasury Department reports that homeowners who were successful in getting permanent modifications on their loans through this program saw a median reduction in their monthly payment of 40 percent—more than $520 each month—amounting to a program‐wide savings for homeowners of an estimated $4.5 billion.

If you don’t qualify for HAMP, your lender may offer you its own modification program. There are also state and local programs that may help. Looking at modifications overall (not just HAMP-modified loans), payments dropped an average of $333.

Be prepared to fill out a lot of paperwork, and provide it more than once if necessary. Start a file, and keep detailed records from the start. Getting a mortgage modified can be a truly daunting process, and there have been numerous reports of homeowners being foreclosed upon while waiting for a loan modification to be finalized.

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Caution: Be extremely careful before you pay someone—even an attorney—to help you modify your loan. The FTC’s Mortgage Assistance Relief Services (MARS) Rule prohibits companies that offer to help homeowners modify their loans from charging upfront fees. Seek help first from a HUD-approved housing counselor—call one at (888) 995-HOPE (4673).

Keeping a modified loan may be just as difficult as getting one in the first place. As default servicing industry website DSNews.com reports, “Fall-out within the program remains high…” Over half of trial modifications started since the program began were canceled because borrowers couldn’t keep up with payments, or were later found to be ineligible for the program. “An additional 58,020 permanent HAMP mods have been canceled” for unspecified reasons, according to the analysis.

Servicers may be partly to blame. The Connecticut Fair Housing Center, in partnership with seventeen legal service organizations and consumer law offices around the country, looked at 655 permanent loan modifications obtained by the attorneys’ clients and found that 154, or 24%, had significant post-agreement problems caused by the mortgage servicers. Problems included hundreds or thousands of dollars in improper fees, erroneous credit reporting, and even wrongful foreclosures.

And there is still that pesky issue of equity. The median HAMP modified loan totaled 118% of the home’s value, which means homeowners may be breathing easier payment-wise, but still at risk of defaulting if they run into any kind of financial problems again. Daren Blomquist, director of marketing communications for RealtyTrac warns that there is a serious risk of defaulting on a modified loan “unless the modification includes some kind of principal reduction.”

Finally, your credit may be affected, though that depends on how the lender reports the modification. During trial phase of HAMP, for example, your credit report may list “partial payment,” which is very negative, but during permanent modification that remark should be removed. Non-HAMP modifications may or may not be reported negatively, but it’s common for lenders to report delinquencies or partial payments on modified loans. Both are negative.