Nolo’s Bankruptcy & Foreclosure Blog

Nothing gets my blood boiling faster than when I see struggling homeowners pay thousands of dollars to hire someone to represent them in a mortgage modification negotiation. My advice is always the same: attempt to hook up with a non-profit HUD-approved housing counselor and dump the commercial service. I also suggest they demand their money back and consider reporting the service to their state's attorney general and the Federal Trade Commission since these services are increasingly illegal.

From the time the foreclosure rates started skyrocketing, self-styled foreclosure-rescue operations landed on at-risk homeowners like locusts on wheat fields. When people still had equity in their homes, the operators of these scams would find ways to separate the mark from his or her home ownership -- supposedly as a temporary means of dealing with the foreclosure. It didn't take long for the home's equity to end up with the scammers and the homeowners to end up on the street.

As home values continued to plummet and homeowners were increasingly underwater on their mortgages, the foreclosure rescue operations turned to charging an up-front fee -- typically in the low thousands -- to replace their previous equity-stripping practices. When modification results were not forthcoming in the face of looming foreclosures, homeowners were told to be patient and that everything was on course. At some point, the homes would be sold in foreclosure and calls to the "rescue" company would go unanswered. 

Quick to respond to these obvious scams, many states have passed new legislation that, among other things, prohibited the collection of "foreclosure rescue" fees prior to the delivery of the service. In addition the Fair Trade Commission recently announced lawsuits in 23 states against perpetrators of these scams. Unfortunately, as is generally true with consumer protection legislation, lawyers have for the most part been exempted from their provisions -- and law firm ads on radio, cable TV and the Internet exhorting people to hire them to handle their modification activities have mushroomed.

Although I have no proof, the timeline of these developments tells me that at least some of these attorneys are simply fronting for the same companies that were scamming homeowners all along. But even if the attorneys are not fronting for foreclosure rescue scams, they might as well be -- as I point out below.

Continue reading "Beware of Commercial Mortgage Modification Services" »

In an earlier blog entry and Nolopedia article, I explain the basic requirements for refinancing a mortgage and having your payment reduced under the Obama administration's implementation of the Homeowner Affordability and Stability Plan.

Now the government has put up a user-friendly website dedicated to helping you determine whether you are eligible to have your mortgage refinanced or your mortgage payment reduced under this new law  In addition to eligibility determinations, the website helps you find a HUD-certified housing counselor and, in a resource section, provides calculators to help you determine your debt to income ratio and your likely payment if you qualify for the program. If you are wondering whether the Obama Administration's mortgage modification programs will help you out, this is definitely the website of choice.

On February 17, the Obama Administration announced its new homeowner affordability and foreclosure prevention plan. On March 4th, the Treasury Department issued guidelines as to how the new plan would be implemented. Despite criticism from all sides, I think the plan is about as good an approach as is possible in the current political and economic climate.

Many articles and blogs that are critical of the program have pointed out the obvious -- that the plan won't apply to many who could use the help, or even to the majority of people at risk of foreclosure, especially those who are losing their jobs at such a rapid rate. There will be widespread injustices in that many people who deserve to get help will fall outside of the guidelines and an equal number of people who get help may arguably not deserve it. The plan is structurally insufficient given the lack of adequate funding. The mortgage modification part of the plan will crash and burn when (not if) the investors sue because they feel it favors the banks and homeowners and neglects their interests. And so on and so forth.

The fact is, there is no way to create a massive housing relief and foreclosure prevention program without its share of problems -- big problems. Still, the Administration's plan appears to successfully thread a very thin needle by making large and hopefully permanent improvements in the home mortgage landscape while avoiding the worst of the moral hazard bunkers -- a political necessity.

The plan consists of two components: a $400 billion refinance program and a $75 billion mortgage modification program (all to be paid out of previously allocated funds). Setting aside the details for a moment, the programs will likely accomplish two important goals:

• The refinance program will potentially transform millions of funny-money loans with uncertain interest rate futures into stable, 15- or 30-year fixed-rate low-interest mortgages. Payments on the refinanced loans will increase in some cases, but the homeowner's participation will depend on his or her ability to afford the new loans. And even though their payment may be higher in the short term, it will be stable in the long term -- no more fear of interest resets. While the refinance program only applies to mortgages owned or backed by the two large federal housing finance agencies -- Fannie Mae and Freddie Mac -- we're talking about half of the nation's mortgages. Overall, the program is bound to have a substantial -- and positive -- effect on the mortgage default rate and the stabilization of home prices.
• Equally important, the mortgage modification program creates a workable approach to modifying mortgages so that payments for many will be brought within the affordability range. Also, for the first time, homeowners can get an objective fix on whether they are eligible for a modification. It's impossible to say what the future holds for the real estate industry, but it makes sense to believe that once mortgage lenders become comfortable with the very idea of modifying loans, only good things will follow. Whether or not the number benefiting from this program will be in the millions -- as predicted by the Administration -- or in some lesser amount doesn't really matter. The overall numbers are sure to be large.

Getting back to the details, let's continue with the refinance program: Even if you have a shot at this program because your mortgage is owned or backed by Fannie Mae or Freddie Mac, you will only qualify if what you owe on the mortgage is within 105% of the home's current value. For example, if your property is valued at $200,000, you won't qualify for refinancing unless you owe $210,000 or less on your first mortgage. This means you probably won't benefit from this program if you live in the areas most heavily impacted by the housing crisis -- home values in these areas are frequently 25% or more below what's owed on the mortgage. You also will probably be disqualified if your loans are jumbo rather than conforming (over $417,000 in most areas, and $729,750 in higher-cost areas like New York and California).

But suppose you're lucky and live in a part of the country where you're just a little upside-down, within the 5% range. Even then you'll need a good payment history (some say good credit is also required) and an income that is adequate to afford the payments under the new loan, which, as mentioned, may be higher than under your current loan, at least for a little while.

In the final analysis, the homeowners who least need a refinanced mortgage are the most likely to get one, and vice versa of course. And this says something very important about both of the new programs: They were carefully crafted so that the Obama Administration could credibly assert that only responsible homeowners would be helped. They didn't want to defend themselves against the allegation that we taxpayers were rewarding bad behavior -- the moral hazard quandary. In the case of the refinance program, only homeowners who have a good payment history and who aren't very much upside down are getting to play. Homeowners who somehow got in way over their head or who have shirked their payment duties will likely not be invited to the party.

The Administration's attempt to only help responsible homeowners is also evident in the mortgage modification part of the program. To qualify for a modification you have to show:

• financial hardship caused by change of circumstances, such as loss of a job, a medical emergency, or an interest-rate reset (if you were in over your head from the beginning, it's unlikely you'll qualify for help)
• risk of foreclosure, meaning you have missed at least two payments, or your debt to income ratio (your DTI) is higher than 31%, and
• sufficient and provable steady income (by way of a tax return and wage stubs) to make the payments required under the modified loan.
  

The ball starts in the mortgage servicer's court. All participating mortgage servicers (so far, most of the big ones have signaled their willingness to play along) must perform an initial "net present value" (NPV) analysis on all loans in their portfolios that are either at least two months delinquent or that are in "eminent risk" of default. Although the guidelines don't define what "eminent risk of default" means, I assume it means loans with a debt to income ratio in excess of 31%.  A loan's NPV is what it would cost (in cash flow) to modify the mortgage relative to the cost of foreclosure and is to be calculated according to parameters set out in the guidelines. Based on past practices, most NPV analyses will favor modification and in those cases the servicer will be required to notify you, proceed with modification discussions with you, and modify the mortgage, assuming you meet the other eligibility requirements.

The ultimate goal for the modification program is to adjust the interest rate and duration of the mortgage so that the homeowner has a debt to income ratio (DTI) of 31% (meaning the payment on the first mortgage, including taxes and insurance, will be 31%of the homeowner's gross income; the mortgage debt that goes into this DTI ratio doesn't include payments on a second mortgage, installment payments, or mortgages on other houses).

The modification is to be accomplished by first reducing the interest rate to as low as 2% and then by extending the term of the mortgage (from its inception) to a maximum of 40 years. Once the payment (through this process) reaches a DTI of 38%, the government will share the cost of the rest of the reduction down to 31%. The servicer also has the option of modifying a mortgage loan by reducing its principal -- with government participation and backing. Last but not least, the program provides monetary incentives to servicers for keeping people in their homes and to lenders for agreeing to modify the mortgage. 

Both programs are designed to operate without the need for homeowners to come forward with a request for assistance. Rather, the servicers will be contacting people for a follow up after their initial eligibility for a modification or refinance has been established. Nevertheless, it would be a good idea for you to consult with a HUD-Certified Housing Counselor to see whether you are being treated fairly under the new plan. To find a counselor, call 1-888-995 HOPE.

Under no circumstances should you pay a counselor for his or her services. A bevy of mortgage brokers have been retrained to modify mortgages under the new plan (in fact, a new trade organization has been created just for "loan-modification experts") and are charging outrageous fees for doing absolutely nothing that a HUD-certified housing counselor won't do for free. Some new mortgage modification companies are hiring lawyers to be front-people for them so that fees can be collected in advance (something that many state laws prohibit). And it's true that lawyers can sometimes be very helpful in preventing foreclosures as such. But, as with mortgage brokers, lawyers have no magic keys to the kingdom of mortgage modifications. Again, for that purpose, you and your wallet will be better off with a HUD-certified counselor.

Sometime this week, the House is expected to vote on H.R. 1106, the bill that would allow Chapter 13 bankruptcy judges to modify residential mortgages. Right now, judges cannot modify mortgages attached to the bankruptcy filer's principal residence.

Without question, an enormous number of homeowners facing foreclosure would be able to keep their homes now and in the future if the principal owed on their mortgage could be crammed down to the home's current market value in a Chapter 13 bankruptcy (and the interest rate reduced to the bare minimum). Not only would foreclosures be avoided, but Chapter 13 itself would become much more available as a remedy, since many Chapter 13 plans fail because of the non-affordability of the filer's mortgage payments.

Previously, I've argued that Chapter 7 judges should also be allowed to modify mortgages, since so many more people file Chapter 7 than Chapter 13. However, half a loaf is better than none, and allowing Chapter 13 judges to bring mortgages into line with the value of the home would not only benefit the filer but would also provide a powerful brake on the deterioration of the residential real estate market.

You can lobby your representative by calling 1-877-354-4958 between 9AM and 6PM Eastern Standard Time only. You will be given specific suggestions for the substance of your phone conversation and prompted to enter your zip code, but the basic idea is that you favor passage of the bill.

Depending on your Congressional district, your call will be routed to the office of your Senator, your House Rep, or the White House.

On Wednesday, February 18, President Obama announced his intention to spend up to $75 billion for direct aid to forestall (hopefully) millions of foreclosures, and to make available $200 billion additional dollars to support refinancing of loans owned or guaranteed by the two giant federal housing agencies, Freddie Mac and Fannie Mae. The guidelines for these programs are expected to hit the press on March 4th. Here's my take on the basics of what has been announced so far.

You might qualify for a refinance at a 15- or 30-year fixed-market-interest-rate (currently a little over 5%) if all of the following are true:

• The loan to be refinanced is a conforming loan.
• Your loan is owned by Fannie Mae or Freddie Mac, or it has been sold by Fannie or Freddie as part of a mortgage-backed security (that is, it's been "securitized").
• You have a history of being current on your payments.
• The mortgage to be refinanced is on your principal residence.
• Your first mortgage is 5% or less over the current value of your home. (For instance, if your home is worth $300,000, you can't qualify if you owe more than $315,000.)
  
• If you have a second mortgage, the mortgage holder voluntarily agrees to continue to play second fiddle (which may be a hard sell).

A separate part of the plan speaks to homeowners who are in default on their loans or who are at risk of defaulting. If all of the following are true, you might qualify for a program that will bring your mortgage-related payments down to a total of 31% of your gross income:
 

• Your mortgage loan is conforming.
  
• Your mortgage-related payments exceed 31% of your gross income (which, by definition, will put you at risk of defaulting if you aren't already in default).
• If your current debt-to-income ratio (mortgage debt over gross income) is higher than 38%, your lender will agree to changes that will bring this number down to 38% or lower.
• The mortgage being modified is on your principal residence (in other words, investors and flippers not welcome here).
  

The plan has certainly brought out the cynics. The populist response seems to be that the plan doesn't adequately protect against "moral hazard," meaning that some undeserving people will benefit. On the other hand, many criticize the bill for precisely the opposite reason, claiming that it doesn't go far enough. The last major government attempt at foreclosure prevention -- the Housing and Economic Recovery Act of 2008 -- fell flat, primarily (in my opinion) because it asked too much of lenders and offered inadequate incentives to get the lenders to cooperate. Also, many mortgages have multiple owners -- often in other countries -- and then, as now, there is no current theory as to how to get these owners to voluntarily agree to changes that will reduce the sums contractually due to them. Still, there are important differences between this program and the last one that offer some basis for hope.

Perhaps most importantly, incentives are being offered to the various parties to do their part. Especially important are the incentives to the mortgage servicers (the folks you make your payments to and negotiate with if you get into trouble). Under current contracts between lenders and the servicers, the servicers make more money off foreclosures than they do off keeping you in your home. Under the new plan, the servicers will be incentivized to keep you from defaulting in the first place and to arrange for a workout designed to keep you in your home for the long haul.

In addition to announcing how he will use existing authority and appropriations to prevent foreclosures, President Obama also announced:

• his support for legislation that would allow Chapter 13 bankruptcy judges to modify residential mortgages on a case-by-case basis
• his intention to require all future recipients of federal money to comply with the modification procedures and standards that are being established in his plan, and
• his plans to piggyback this most recent plan on top of the HOPE for Homeowners Act (part of the up-to-now failed Housing and Economic Recovery Act of 2008).
  

Despite what's good in the bill, there are some major unanswered questions which await the March 4th guidelines. For example, in a penetrating article in the San Francisco Chronicle on February 19th, business writer Kathleen Pender has raised some vexing questions about how the bill will play out, especially the requirement that the applicants for relief be "responsible borrowers".

Personally, my biggest problems with the bill are: 1)  in the heavily impacted parts of the country, people are underwater much more than 5% over the value of their house, and in many of the impacted coastal urban areas, the loans are non-conforming (that is, jumbo) loans, and 2) I strongly believe that making the mortgage modification power available to Chapter 7 as well as Chapter 13 bankruptcy judges would greatly expand access to that remedy by homeowners who have no other option.  

Again, we'll know more on March 4th and have a better view of  the devils lurking in the details. Look to the Nolopedia's Bankruptcy & Foreclosure resource centers for more comprehensive articles in the weeks following March 4th. And for now, take a look at the Q&As published on the U.S. Treasury's website (PDF) to get more information.

In earlier blog posts, I've tried to keep up with the various foreclosure prevention programs offered by major mortgage lenders. Every major mortgage lender has some sort of policy in place to handle requests for mortgage modifications. Some polices require that you be at least three months behind on your mortgage -- Fannie Mae and Freddie Mac among them. Other lenders -- Bank of America and Indy Bank among them -- don't require that you be delinquent. Some lenders will work with you if you are in bankruptcy (FHA-insured mortgage holders among them) while others won't. Unfortunately, there is no standard, across-the-board modification policy.

As statistics mount regarding the lasting effect of modifications, it's clear that many people simply cannot afford their house, even at the level of payment provided for by the modification. In fact, according to information published by the National Association of Consumer Bankruptcy Attorneys in December 2008, payments actually increase under many modification arrangements and, overall, voluntary mortgage modification programs just don't work for a variety of reasons. A recent article in BusinessWeek makes a persuasive case that the banking industry has made the foreclosure situation worse through its lobbying efforts to stall for time in the hope that home values would recover on their own.

Many consumer-oriented commentators, including NACBA, make the case that Chapter 13 bankruptcy judges should be allowed to modify mortgages on a case-by-case basis. The Heritage Foundation, on the other hand, makes a strong argument against bankruptcy-originated mortgage modifications. While I reject much of the reasoning in the Heritage Foundation article, for reasons stated in a previous post, I don't think Chapter 13 cram-downs alone will provide much of a solution; I do think that allowing cram-downs in Chapter 7 bankruptcy would go far to prevent foreclosures.

In an article published in the New York Times on Friday February 13, Alan Zibel reports that the major mortgage owners have put a hold on foreclosure evictions, pending the much-anticipated announcement of the federal foreclosure mitigation policies. According to Zibel, Fannie Mae and Freddie Mac, JPMorgan Chase & Co., Morgan Stanley, and Bank of America Corp. have all extended non-eviction policies originally put in place shortly before Christmas until sometime in early or mid-March. Or, for some lenders, at least until President Obama announces the new federal policy -- currently expected to take place on Wednesday, February 18th.

Details of the new policy have been hard to come by in advance, except that the program is expected to cost up to 50 billion dollars and will not require that eligible homeowners be behind on their mortgages. One leak has it that the program will involve direct payments by the federal government to effect reduction of mortgage payments to 31% of the homeowners' income. The answers to the big questions -- who will be eligible for these payments and how eligibility will be determined -- are still wrapped in mystery, except that the program is expected to only apply to homeowners who have acted in good faith when acquiring their troubled mortgage. Good luck on that one. Any policy that attempts to discriminate between the deserving and the undeserving is bound to create immense resentment among those who are left out. And, at least in some cases, the resentment will be well-founded.

Throughout the mortgage meltdown crisis, many democrats and bankruptcy professionals have favored a change in the bankruptcy laws to allow Chapter 13 bankruptcy judges to modify residential mortgages -- something they can't presently do. Legislation to this effect was originally introduced in mid-2008, but failed because of staunch opposition by the mortgage and banking industries.

The legislation has been reintroduced in both houses of Congress (SB 61 and HR 200) and is expected to pass this time around (in modified form), due to the severity of the foreclosure crisis, the change in administrations, and, most recently, the support of a major bank. Last week, the Wall Street Journal reported that Citibank had broken ranks with the Mortgage Bankers Assocation and is supporting the new legislation -- provided that homeowners be required to seek a voluntary modification first. As with other legislation regarding bankruptcy and foreclosure prevention, its highly probable that this proposed legislation will change in many respects prior to its final passage.  

As I've pointed out in earlier posts on this subject, I'm not against the concept of mortgage modifications in bankruptcy. I am, however, concerned that the Chapter 13 remedy for foreclosure prevention is limited to a relatively small number of would-be filers due to Chapter 13 eligibility requirements, and the associated legal costs consisting of fees that can reach upwards of $3,000. Keep in mind also that over 2/3 of Chapter 13 bankruptcies fail and are either dismissed or converted to Chapter 7 -- although it's sometimes possible to modify the plan or obtain what's known as a hardship discharge. Most importantly, modifications initially obtained in a Chapter 13 bankruptcy may no longer apply if the plan fails.

In short, I think the Chapter 13 remedy is being over-hyped as a solution to the foreclosure crisis. Of course, less plans will fail if mortgage payments are reduced, but there is no way to tell what effect -- if any -- the reductions will have on the success of Chapter 13 plans overall. Another less-heralded part of the proposed legislation should add to the success of Chapter 13 plans -- under the legislation, mortgage payments are to be made directly to the lender by the homeowner. This is very important because many Chapter 13 trustees currently require payments to be made as part of the plan, which entitles them to a 10% commission on all mortgage payments over the life of the plan. This extra amount often makes Chapter 13 plans unaffordable for many would-be filers. For example, 36 monthly mortgage payments of $2,000 payable through the plan would generate a trustee's fee of $7,200, whereas no fee would be generated if under the direct payment requirement, so filers will save some serious cash.

To address the shortcomings of Chapter 13, the mortgage modification remedy should be extended to Chapter 7 bankruptcies. Like Chapter 13, Chapter 7 has a system for assessing the current value of personal property and reducing the obligations accordingly. This same system could be used to assign a current value to homes and both reduce the mortgage to that value and reduce the interest rate to the current prime rate, plus a point (the going formula for assigning interest rates in bankruptcy).

Simply put, Chapter 7 bankruptcy is far less expensive than Chapter 13 bankruptcy and is far more available to the millions of homeowners who may be in need of relief to prevent a foreclosure from occurring.

Earlier this week, the IRS announced a new policy designed to help homeowners refinance or sell their homes.

Under this policy, homeowners whose homes are burdened with an IRS lien for unpaid taxes can apply to have this lien made secondary to liens by a lending institution that is refinancing or restructuring a loan. The policy would also allow the IRS to reduce or remove the lien in cases where a short sale is being proposed. These policies would make it easier to obtain loans since the lender's liens would be first in line.

Undoubtedly, this policy will help some homeowners in some situations and that's good, but it should be looked at as just another Band-Aid. Only if a truly systemic program is implemented to address the root causes of the foreclosure morass will the crisis be solved.

It may be that we have a case of Humpty Dumpty here -- everything was fine as long as the real estate bubble continued to expand, but once housing fell off the proverbial wall, nothing can put it back together again.

In the last several months of 2008, the federal government and various private lenders have offered a variety of voluntary mortgage modification programs. The main ones are:

• the HopeNow program (created in 2007 by a consortium of private lenders)
• the Hope for Homeowners program (created by Congress as part of the Housing and Economic Recovery Act of 2008)
• a program recently crafted by the U.S. Treasury Department which is only available to homeowners with mortgages owned or insured by Freddie Mac or Fannie Mae (which greatly resembles the HopeNow program), and
• lender-specific modification programs offered by such entities as IndyMac, Bank of America, Citibank, and Wells Fargo.

Statistics released in a report by the National Association of Consumer Bankruptcy Attorneys show that these modification programs are themselves little more than a scam. Few modifications have occurred under these programs, and those that have are insufficient in terms or reductions to stem the tide of foreclosures other than on a very temporary basis. 

According to the NACBA report, many are the reasons why these programs have failed. Some of them are so insufficiently staffed that they're not much help while others offer the lenders insufficient incentives for them to agree to the modifications. Still another reason for failure is that many mortgages are owned by a variety of investors and it's impossible to bring the various investors collectively on board for any particular modification.  

Based in part on the failures documented in its report, the NACBA is pushing hard for a modification of the bankruptcy laws by Congress to allow Chapter 13 bankruptcy judges to reduce mortgages on principal residences to the value of the residence. Other sources indicate that such legislation will likely be introduced early in the Obama administration's term and will likely be successful.

While Chapter 13 bankruptcy is the obvious program to accomplish these modifications, many homeowners are unable to complete a Chapter 13 bankruptcy, which requires compliance with a repayment plan for a three to five year period. And, in many cases, homeowners won't qualify for Chapter 13 for a variety of reasons.

In my opinion, the bankruptcy legislation that is sure to be introduced in the next Congress should also include a program under which a mortgage can be modified in Chapter 7 bankruptcy. There is no inherent reason why Chapter 7 couldn't accomodate mortgage modifications -- as it stands, Chapter 7 already offers a procedure where the court determines the value of cars and other personal property for the purpose of deciding on a redemption price. This same procedure could be used to determine real estate values for the purpose of modifying mortgages. Allowing Chapter 7 bankruptcy judges to modify mortgages would greatly increase the number of homeowners who would be helped in bankruptcy court.