Rules Set for Mortgage Modification

By Holden Lewis, bankrate.com | Published: 3/12/2009

Folks who can afford their mortgages but need help to refinance to lower rates don't get a lot of help.

The Obama administration's housing plan encourages lenders to modify the mortgages of homeowners who can't afford their monthly house payments because of hardship. The definition of hardship is loose and includes: lost income, increased expenses, payment shock from an adjustable-rate mortgage, and "other indications of being at risk of default."

Qualified homeowners would keep their current loans, but the payments would be reduced to 31 percent of before-tax income. Most borrowers would see their payments rise after five years.

The aim of the Making Home Affordable program is to "prevent the destructive impact of foreclosures on families and communities," according to the Treasury Department.

Two weeks ago, the Obama administration announced the outlines of the foreclosure prevention program, which then was dubbed the Homeowner Affordability and Stability Plan. The guidelines for the mortgage modification plan explain who is eligible and how those monthly house payments are reduced to 31 percent of income.

Here are some qualifications to be eligible for a loan modification:

• It has to be the homeowner's primary residence, and must be occupied and habitable.
• The balance on the first-lien mortgage can't be more than $729,750 for a single-family home.
• It's OK if foreclosure proceedings already have begun or if the borrower is suing the lender.
• If the borrower qualifies, then the mortgage servicer figures out what it will take to decrease the monthly house payments to 31 percent of income.

• Under this plan, the house payment includes principal, interest, taxes, homeowners insurance (including flood insurance), and homeowners association or condo fees. It excludes mortgage insurance premiums.
• Past-due interest, taxes and insurance are added to the mortgage's balance. Late fees must be waived.
• As a first step, the lender drops the interest rate as low as 2 percent. If that's sufficient to bring the payment down to 31 percent of income, then that's the rate. For example, if cutting the interest rate to 4 5/8 percent drops the payment to the 31 percent threshold, the rate doesn't go any lower.
• If dropping the rate to 2 percent doesn't do the trick, the next step is to extend the term of the loan up to 40 years. It doesn't have to be 40 years; it's all good if a 2 percent rate over a 37-year term brings the monthly payments down to 31 percent of income.
• If a 2 percent rate and a 40-year term don't get the payment down enough, the third step is to "forbear principal." This means that the borrower owes the same amount as before but pays interest on only part of the mortgage balance. For example, someone might owe $300,000 but pay 2 percent interest for 40 years on $250,000. All $300,000 must be paid back if the homeowner sells the home or refinances the mortgage later.

For example, if Freddie Mac's weekly mortgage rate survey says the average rate on a 30-year fixed in a given week is 5.3 percent then a modification that's approved on that date will have a rate that eventually rises to 5.3 percent. It might go from 2 percent to 3 percent in Year 6, then to 4 percent in Year 7, then 5 percent in Year 8 and finally 5.25 percent in Year 9.

For at least a year, the mortgage world has recognized the need for one national standard to decide who gets a mortgage modification and who doesn't. Academic studies have shown that different servicers apply wildly different rules governing modifications. Housing counselors say there's a lot of variation within mortgage servicers, too. These guidelines are designed to elicit more consistency.

"From where we sit, it's important that there's a recognized framework for modifications," says Douglas Robinson, spokesman for NeighborWorks, a government-sponsored nonprofit that trains and provides funding for housing counselors.

Distributed by Scripps Howard News Service.

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