Modifications,Short Sales,Deeds in Lieu,WriteDowns

The Problem With Modifications

Posted on Wednesday, February 18, 2009

Many borrowers are defaulting on newly modified loans. Some call modifications a band-aid approach.

1.A BIG LOAN BY ANY NAME IS STILL A BIG LOAN. A modification addresses mortgage loan terms such as the interest rate and amortization period. A modifications to reduce principal are still rare but may eventually emerge as a solution of last resort. Modifying rate and amortization can only do so much to impact a monthly payment amount on a loan with a principal amount that was too big for the borrower to realistically afford and be given to begin with. It like the difference between buying a Mercedes at $100K or a Toyota for $20K. If you can really only afford the 25K Toyota, even if you don’t have to pay any interest, the $100K Mercedes is going to be tough for you to pay for. This is also one of the reasons adding to problems in the real estate market recovery. During the bubble, the percentage of large, expensive homes with luxury amenities like granite counter tops and stainless steel appliances grew to number far exceeding the number of more modest, affordable homes you would typically expect an average American to buy. We’re talking about a lot more Mercedes homes being built in say the 400 to 600K price range than Toyota homes built in the 200K price range. But remember, in real life we never actually had larger numbers of Mercedes buyers, only Toyota buyers who banks were giving Mercedes loans to. So now we have all these 400 to 600K homes left over and a bunch of 200K home buyers. This is really slowing down the absorption of inventory. Eventually many of the 400 to 600K homes are going to have to be sold to 200K buyers for a lot less than 400 to 600K or they’re not going to sell for a long time. The arm wrestle now is whether the developer or the bank is going to eat the difference. Since most developers have been sucked dry, we all pretty much know the answer to that question.

2. HIDDEN COSTS. Just as important is the fact that, even if we reduce a borrower mortgage on a home that’s more than they should have bitten off in the first place, say they should have been in a more modest 2500 sf home but instead bought a mid-bubble mcmansion that’s 4000 sf., buying homes is not like buying shoes. With shoes, say you can normally afford a pair for $20 bucks at Payless but one day you get this wild bug and go spend $700 on a pair of Manalo Blahniks, once you’ve taken that big bite you’re done with the price difference. When the shoes need new heels, you’re going to pay the same price for new heels for either pair. But a home is different, the on-going “hidden” costs for a 4000 SF home are much higher than for a 2500 one. Taxes are higher, insurance, homeowner fees, even utilities and lawn care. Replacing the bigger roof can cost twice as much as can maintaining 4 a/c units instead of two. Even your housekeepers going to charge more. And for some people these costs will continue getting higher. In many of the new mcmansion and condo communities hardest hit by the crises, homeowners who are still there have to cover the assessment costs for those who have been foreclosed or where never sold of for the developer when he goes under. These instances are going to continue growing before they get better. So even if we modify loans for folks, eventually, if these other costs are going to put many of them under. You’d think the professionals helping them with the modifications would tell them this but I’m finding a lot of the people doing modifications today were the exact same crooks who were doing the crappy subprime mortgages 5 years ago.

3.OTHER VARIABLES. People default after modifying for a lot of other reasons, some of which we may not even be able to anticipate now. For example, unemployment is growing, new kinds of fraud are emerging (for example, homeowners are actually trying to do short sales to friends and family only so they can eventually get the same house back for a lot less money) and as prices drop more and more people realize they’re upside down in their homes so even if they’ve modified their loan, they may still decide to give the bank the house back and default – it’s becoming the American way and a prime example of what a “Foreclosure Nation” means.

4. HISTORY. That lots of people will default even after modifications should come as no surprise. Roosevelt did the same thing in 1933 with the Home Owners Loan Corporation and $3.5 billion in taxpayer money. Our government ended up holding 1 in every 5 US home mortgages. Eventually 20% of those borrowers defaulted. It took the HOLC years to sell off the properties. With the other ingredients in our mix today and, just as important, the cultural acceptance we’re seeing of foreclosure and bankruptcy in general, I’d expect the percentage of defaults after modification to be even higher.

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The problem with Modifications are many. If you are upside down and expect the home to increase in value over say a 20 year time frame and you have no balloon payment attached to the Modification and /or deferred principal. My home is valued at 235K now the Modification loan balance is 357K with a 70K deferred principal amount and a 131K balloon payment if: (a) I either refinance or sell the home I must pay BOTH first to the lender. This is for owing the bank 20K in back payments and taxes. This is NOT a good deal for a Loan Modification in my book.

Cali 6/27/2009

It depends on who owns your loan, but most of the time only once.

Alex 3/13/2009

How many times can I modify my loan?

Monique R.  3/13/2009
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