Deleveraging Through Loan Modification

With all the de-leveraging, especially when it comes to the price of real estate, I was wondering what can be done about homeowners who are under water. These people have seen their equity disappear. Importantly, many of them can still afford to make their mortgage payments, but they no longer have a stake in the game. They now have a house worth the amount of the outstanding loan amount or worth less than the loan amount. Their quandary is whether to keep paying their mortgage or walk away, take the hit on their credit rating and go lease until they save enough money to re-enter the housing market after prices stabilize.

I’ve seen estimates that it costs a lender $50,000 to $80,000 on average to liquidate homes that have been foreclosed or handed back to the lender. My idea is that instead of a viable mortgage payer walking away and a lender taking a huge hit, what if there was a way to keep the homeowner in the house and protect the lender as much as possible.

I suggest that the following loan modification be done. The mortgage payment would remain the same. However, the interest portion of the payment would go towards reducing the outstanding loan amount. Based on a current appraisal value, this pay down of the loan amount would continue until loan to value reaches 80%. At that point, the new mortgage amount would be re-amortized based on the remaining term and at the current market interest rate or the previous interest rate, whichever is higher. Finally, the lender would receive a 5% ownership position in the property.

Example: A house originally purchased for $500,000 with a $400,000 30 year fixed loan at 6% (monthly payment $2398). Now the house is worth $400,000, the amount of the outstanding loan amount. To achieve a 80% loan to value the loan would have to drop down to $320,000. With the entire monthly payment going towards the loan pay down, it would take approximately 33 months to reach the $320,000 level. At that point the loan would reset at 27 years at 6% (monthly payment would drop to $1,990 ). The homeowner would have 3/4 of the 20% equity ($60,000) and the lender would have the remaining 1/4 ($20,000 ).

So what are the results of such a loan modification? For the homeowner, they have a new stake in the game again without destroying their credit, and it was done without any changes to their monthly payments plus eventually resulting in lower payments. For the lender they receive no interest for 33 months (approximately $66,000). They have not taken a hit on the principal amount though. They have avoided the cost of liquidation ($50,000 to $80,000). And they now have a loan to value of 80% and a 5% ownership position. And lastly one less house didn’t have to be added to the inventory of unsold homes.

Comments

[James H.:]

This is accurate information and relevant to today's economic troubles. If you are facing a possible loan modification or short sale or are assisting a client who must do so, Option Next can really help. They can facilitate the process and have the expertise to get the negotiations done right and in the best interest of the homeowner and brokers. The homeowner walks away with a more manageable loan or a settled debt with the bank and the real estate or mortgage agent still receives payment for his/her services. email [e-mail] if you need any help or have questions.

Jan 12 11:25 AM

[Jon Smirl:]

I know of two people now that have purposely left their houses go into foreclosure because their loans were underwater. Both couples were able to make their payments but they hid that fact from the foreclosure process.

Both are in rentals now. One is paying $500/mth more and the other is paying $800/mth more. Both think they beat the system because they escaped from being underwater $100-200K.

Personally I think they are both worse off. They are paying more per month for a rental that is not as good as what they lost. The rent is not deductible and they aren't building any equity. When housing comes out of its depression they won't participate in any upside. When they buy in the future they are going to pay a higher loan rate.

If your rent is going to be more than your payments, it is stupid to go into foreclosure just because you are underwater. The probability that you will still be underwater when a 30 year loan is finished is pretty close to zero no matter how far you are currently under. The impact of inflation over the next 30 years will far exceed the current housing depression.

Jan 12 01:28 PM

[cadoggy:]

Jon Smirl... you're assuming people can or want to stay in their homes long term. Sure, if you plan to be there 30 years then why walk away?

People move for various reasons including new jobs, weddings, divorces, children, etc. For someone who needs to move in the next 5 years and is underwater $100k it absolutely makes sense to walk away. In CA you leave with no deficiency judgment in most cases.

And it's not necessarily true that walkers will pay higher interest rates later just because they had a foreclosure... you'd be surprised how little a foreclosure affects your credit score 5 years down the road.

Jan 12 03:45 PM

[Dave W:]

No doubt the housing market is broken and putting us and our children and their childrens children in debt to fix it is stupid. We need an accross the board loan modification for anyone who purchsed or refinanced from January 01, 2000 to current.

I would like to draw your attention to a grassroots group of homeowners and investors who are trying to do just that, force a mass modification. They call themselves The American People's Fix and their website is americanpeoplesfix.com.

Their solution is simple but has far reaching implications. Here is the solution: Take your existing mortgage balance and divide by 240. The answer is your new principal only payment for 20 years.

With some 12 million homes underwater this plan will accelerate the mortgage balance pay down so that the home value and mortgage balance will be equal in 5 to 7 years. It will reduce the monthly payment, which becomes it's own economic stimulus plan every month. Money that can be spent on further reducing the mortgage balance, pay bills, spend in the general economy or save. The lender gets their money back, but does not earn a profit. The Federal and State government get increased income without increasing my taxes, because I don't have a mortgage interest tax write off.

I am much more inclined to stay in my home if I know that in 5 to 7 years I can sell without writing a check or doing a short sale or refinance without writing a check as well.

Right now I am a renter in my own home, I'm 59 bought in September of 2006 and put 20% down on a $320K home in Arizona. I qualified full docs and am not late on my payments nor am I in financial distress.

I just can't sell or refinance because I'm 50% underwater. I've lost my $64K and would have to write a check for $96k if I had to sell today.

I've worked all my life and raised my family and paid my bills and earned my good credit. Now I may be forced to loose everything in my home and my credit to boot. Where is my bailout? That's why I joined The American People's Fix.

My American Dream has become my Retirement Nightmare!!!

Jan 12 04:34 PM

[E Thomas St.:]

Dave, you took out a mortgage to buy a home at age 59. Period. Request Denied!

On Jan 12 04:34 PM Dave W wrote:

> No doubt the housing market is broken and putting us and our children
> and their childrens children in debt to fix it is stupid. We need
> an accross the board loan modification for anyone who purchsed or
> refinanced from January 01, 2000 to current.
>
> I would like to draw your attention to a grassroots group of homeowners
> and investors who are trying to do just that, force a mass modification.
> They call themselves The American People's Fix and their website
> is americanpeoplesfix.com.
>
> Their solution is simple but has far reaching implications. Here
> is the solution: Take your existing mortgage balance and divide
> by 240. The answer is your new principal only payment for 20 years.

>
>
> With some 12 million homes underwater this plan will accelerate the
> mortgage balance pay down so that the home value and mortgage balance
> will be equal in 5 to 7 years. It will reduce the monthly payment,
> which becomes it's own economic stimulus plan every month. Money
> that can be spent on further reducing the mortgage balance, pay bills,
> spend in the general economy or save. The lender gets their money
> back, but does not earn a profit. The Federal and State government
> get increased income without increasing my taxes, because I don't
> have a mortgage interest tax write off.
>
> I am much more inclined to stay in my home if I know that in 5 to
> 7 years I can sell without writing a check or doing a short sale
> or refinance without writing a check as well.
>
> Right now I am a renter in my own home, I'm 59 bought in September
> of 2006 and put 20% down on a $320K home in Arizona. I qualified
> full docs and am not late on my payments nor am I in financial distress.

>
>
> I just can't sell or refinance because I'm 50% underwater. I've
> lost my $64K and would have to write a check for $96k if I had to
> sell today.
>
> I've worked all my life and raised my family and paid my bills and
> earned my good credit. Now I may be forced to loose everything in
> my home and my credit to boot. Where is my bailout? That's why
> I joined The American People's Fix.
>
> My American Dream has become my Retirement Nightmare!!!
>

Jan 13 02:49 PM