Because I’ve spent the last several years working with Real Estate Investors and homeowners and because the market for real estate has changed so dramatically, I am now getting many calls from owners of Single Family real estate that are in real distress. I am often asked "Is it possible for a Homeowner to Negotiate a Mortgage Modification with a Lender?" The answer is yes.

It is possible to "Do It Yourself"  (DIY) project and to work directly with a lender or loan servicer/trustee, but before you try this approach, take a look at the information and discussion below and carefully consider your alternatives. If you are interested in a deeper look at news on legislation related to foreclosures and other credit issues, see my blog at http://unsustainabubble.com .

Home owners in a real estate markets with rapidly falling values are in trouble with loans that have variable interest rates that have adjusted or are about to adjust. Usually they are in trouble because of an illness in the family that has reduced or eliminated vital income, or there is trouble in typical two income families (where both incomes are necessary because of the size of a house payment and there is a loss or reduction of employment for either spouse). More and more, divorce is becoming the issue as payments are too large for either spouse alone. Sometimes it is a simple matter of too much negative cash flow.

Borrowers in trouble are searching for answers to very difficult questions. By some accounts, more than 25% of all residential loans in California at the end of 2005 were Adjustable Rate Mortgages (ARMS) with similar or higher percentages in other Bubble markets like Arizona, Florida and Nevada. Interest rates on these loans are "resetting" now and will continue to do so into 2009. There is also a large wave of Alt-A and A paper ARMS’ that will reset into 2011. In most cases this means a big increase in interest rates and in the size of monthly payments due.

In many cases, the current value of properties in these areas is well below the balance of all outstanding loans and the property is considered to be "upside down". Where payments remain affordable to the borrowers this is not a problem. Over the long term (maybe the long, long term), values should go up again and if the borrowers were not making house payments, they would be making rental payments somewhere, without the benefits of interest and depreciation deductions available to homeowners and investors. Of course rental payments may be far more affordable than current house payments, but there is a huge emotional block for homeowners who do not want to face up to moving from a home in a good area to an apartment, even if it is in the same area. A quick look at the rental prices for equivalent housing in your area will give you an idea of what the premium is today for owning versus renting.

When payments are no longer affordable, many consumers have chosen to ignore the problem for too long and borrowed more money to keep up payments, hoping the problem might go away. Some have simply walked away from their homes and investments.

Borrowing alone will never solve the problem of too much debt of any kind. Too much debt and an underlying economy going backwards will generate a correction, typically with lower prices in bubble markets ( ironically due in part to restricted availability of credit). For my views on ongoing issues and challenges created by the credit bubble see my blog at http://unsustainabubble.com.

Everywhere you look in the media there are stories about Sub-Prime borrowers who are in trouble on their home mortgages. In general people do not realize that 1/3 of American Homeowners own their home "Free and Clear" and have no mortgage.

Most homeowners are current on their mortgage, but all we hear about are those who are not. Unfortunately, if enough Sub-Prime borrowers give up their homes, or cannot keep them, the entire market is affected by oversupply and prices will continue to drop, which affects all borrowers. This will impact prices on homes owned by Alt-A and A borrowers and make the problems worse between now and 2011.

Stories in the media are about working people (often with marginal credit histories) who made the decision to try and reach for the American Dream of "Home Ownership", using one of the widely available, low or no down payment, Adjustable Rate Mortgages (ARM’s) or Option ARM’s. Option ARM’s offer a menu of payment options, most of which do not "fully amortize" (pay the amount that will pay off or "retire") the loan during the loan term.

Many ARM or Option ARM borrowers did not understand the terms and conditions of their loan contract and many lenders will no doubt be sued as a result of violations of the Truth in Lending Act (TILA) or the Real Estate Procedures Settlement Act (RESPA) related to these loans. Sadly, minority borrowers were steered into these loans by unscrupulous salespeople and this is a real issue in many areas of the country. At the same time, many of these minority, majority and speculative borrowers understood exactly what they were buying, but saw the profit potential of doing these transactions in a market that appeared to be going up forever.

It remains to be seen what the success of these individual and class action suits by borrowers will be against the incredibly deep pockets and top notch law firms retained by the large lenders still in business or what remains of the many lenders and mortgage brokers that have failed.

Articles very seldom discuss "well qualified borrowers", the people with good jobs and credit and who could afford to put down 5-10% or more on their property. They do not discuss the speculators who hoped for quick appreciation on properties in rapidly appreciating areas, using "stated income" or so called "NINJA" (No Income,No Job, No Assets) or "liar loans", (some of which required little or no down payment), to purchase and "flip" properties just a few months after purchasing them, presumably for a fat profit on the highly leveraged down payment.

Likewise there has not been much discussion of otherwise well qualified buyers who purchased the largest possible property with the highest leverage (lowest down payment and lowest cost loan terms) they could, thinking that they could "move up" to something even better , based on profits from the sale of that property, rolled up into the next purchase. In California and some of the other "hot" markets, some real fortunes have been made by the most able, shrewdest buyers/investors during the growth of this real estate bubble and real money has been made by those blessed with lucky timing too. For a sizeable percentage of buyers, the real estate downturn presents a number of choices, any of which could mean sizeable financial loss, bankruptcy or even financial ruin. Some will be starting their financial lives over as renters.

If home prices had continued to go up (historically this is an enormous "if") or even if they had stayed the same, and interest rates remained steady for these borrowers things would be OK. Author and Academic, Dr. Robert Shiller has suggested that the real rates of return on residential real estate have averaged under 1% since the 1890’s. (www.econ.yale.edu/~shiller)

If borrowers had left the bulk of their equity in their property instead of using their home as an ATM by accessing Home Equity Lines of Credit (HELOC’s) and spending the money, there would be no need for this discussion. Mortgage Equity Withdrawal (MEW) peaked in 2005 and Home Equity Lenders are unilaterally reducing or closing some equity lines in areas with declining prices, leaving those borrowers with reduced or no access to equity in their homes. Of course there were a few savvy individuals with perfect timing who bought and sold and used leverage wisely to create wealth and did not own any over leveraged real estate when the market crashed.

Everyone knows deep in their heart that "There Is No Such Thing As A Free Lunch" (TINSTAAFL). If you borrowed more than you could really afford and banked on appreciation or new borrowing to float your boat, you helped create the risk of loss that we are all now experiencing in the marketplace. In the overall euphoria of an unnaturally long up market most of us forgot or ignored the reality of historical market cycles in Real Estate (What Goes Up Must Come Down) every 10 years or so.

Wall Street and the Bankers did little to slow down the business that generated the profits they were raking in. Now the time has come for all to pay the piper and the cost will hurt many Americans for years to come. It is unclear whether the Wall Street or Big Banks will pay their fair share of the losses that they helped create for consumers especially in the "Sub-Prime" market we have heard so much about in the media. Bailouts have primarily benefitted big investors, not the little guy.

For those still trying to stay in a home with some equity, or those who want to fight to keep what they have, there is the possibility of negotiating with a lender for a "Loan Modification" agreement that could substantially improve the terms of an existing loan and allow the borrower to stay in their home. Of course if the home is in the foreclosure process already, the remedy of a loan modification may be difficult or impossible.

As a DIY project, the successful negotiation of a loan modification presents a steep uphill climb for the average borrower, but it is possible and the costs are mostly in time and anguish (but may involve attorney fees too). There are reputable consumer oriented services, "Loan Modification Facilitators" (LMF) that offer to help consumers with this process, but they must be carefully evaluated before a commitment is made and the borrower needs to clearly understand the obstacles they face in the process.

This is a relatively new business concept, created by market conditions and many new businesses claim to offer similar services. A reputable Loan Modification Facilitator is affiliated with legal professionals who specialize in real estate and contract law, especially RESPA and TILA. If you are speaking with a service that has no affiliation with a licensed attorney who reviews your documents, walk away and look elsewhere. Similar services offer only to assist a homeowner to process the paperwork necessary to walk away from a mortgage and do not do any kind of document review. This type of service may be beneficial if you have made the decision to walk away, but if you still have time, why not evaluate all of your options?

The strongest argument for using this type of consumer service is the fact that they specialize in these services, have affiliations with specialized real estate attorneys and connections with the banks, loan servicers and other trustees that handle your loans. They know which lenders are making modifications and which are not. In this market they are negotiating all day, every day with lenders and servicers. A reputable LMF will be able to demonstrate successful results by enabling you to contact clients who are happy with the service rendered. There is a cost on the front end for these services that runs somewhere between $1000 and $5000. This is a fee that must be recognized and paid. Anyone that uses a consumer service like this needs to clearly understand that requesting a loan modification, even with professional help, may not result in getting a modification or in some cases, enough of a modification to effectively save the property.

You must weigh the cost of the service and the possibility of a modification against the possibility, that (due to the specifics of your loan contract or the policies of your lender or servicer), you may not get the results you desire. This means that you will have paid fees to an LMF  or attorney fees without a positive result. In any case, if you cannot negotiate a modification you will truly know exactly where you stand on your loan and you can then look at your alternatives (Loss Mitigation through a short sale, deed in lieu of foreclosure, etc.) to make an informed decision. In almost any case the cost of these services is far less than the economic loss of losing your property and far cheaper than the costs of deposits for a rental property if you have to move.

An LMF may also have the ability of offer help with other Loss Mitigation Strategies on a fee for service basis. Typically no guarantees are made by an LMF and I will now attempt to explain why this is the case.

While the original idea behind Sub-Prime loans was for marginal buyers to have the opportunity to buy a home, the sad fact is that Sub-Prime loans were designed to generate more revenues for their originators and brokers and fees for the servicers of the "Securitized" loan pools. These pools became very profitable and in demand on Wall Street and by investors all over the world (supposedly because of higher than average returns with minimized risks to investors).

The availability and profitability of Sub-Prime loans indirectly fueled the sales of even more real estate to owner occupants and speculators. Clearly the originators were never concerned about the possibility of a bubble or the ability of borrowers to repay in an economic slowdown, since they were able to sell off the loans they originated to Wall Street as fast as they could process them and the profits at all levels have been enormous in the short term.

Of course a few Sub-Prime borrowers who would not otherwise be able to qualify for a home were able to do so and are able to keep up their payments now (especially if they bought wisely, financed with 30 year fixed rates in areas where prices have not been affected by the bubble and did not borrow against equity). This is a good thing, but the absolute numbers of these types of buyers is very small compared to the havoc created in the overall marketplace by the availability of these loans to all borrowers and the incentives to the creators and sellers of these loans to sell them.

Unfortunately the commission and profit structures of these loans incented brokers to sell them to borrowers that could easily qualify for loans with much better rates and terms (the so called "A and Alt-A paper") loans. There was little in the way of regulation to keep lenders and brokers from steering borrowers into Sub-Prime loans except their own ethical standards. In hindsight, there could have been strict rules for qualification and classification of borrowers, but why spoil all the fun? As the American author Sinclair Lewis once said, "It is hard to get a man to understand a thing, when his salary depends on his not understanding it."

While many originators were reckless and greedy, at the same time, very few borrowers walking in to a lenders office knew or understood their own credit profile and most did little or no research before borrowing in order to see and compare what the best available terms should be, given their credit history, income and overall circumstances and perhaps one in twenty had the discipline to create a written budget that anticipated the increased costs of a new home and a new loan over time. Ultimately, we are each responsible for our actions in this regard.

Having said all this, I have set the stage for a discussion of the real difficulties faced by borrowers attempting to negotiate a loan modification.

I read an article by a respected New York attorney that said, "It is estimated that more than 75% of the Single Family loans originated in 2006 were funded by the securitization process. Among the approximately six hundred billion dollars of subprime mortgages originated in the year 2006, some 75% of those were funded by the securitization process. That 75% figure also creates some concern when observing that such percentage of securitized subprime mortgages vintage 2004 and 2005 with a hybrid loan structure have a fixed rate for two or three years, then adjusting to a variable rate for the balance of twenty-seven or twenty-eight years.

Because, though, the spread between the initial rate and the fully indexed rate usually varies from 300 to 600 basis points, a substantial number of borrowers are or will imminently be faced with increased interest rates which they may not be able to afford". (Editors Emphasis added-this means higher or much higher monthly payments for the borrower)

All the publicity previously mentioned has ripened into a storm of events forming the subprime meltdown. In the resultant credit crunch, here are some of the events occurring which then impact upon borrowers’ ability to rescue themselves: (Editors Emphasis added)

This same attorney feels that securitization has created a servicing structure for mortgages that is not very conducive to negotiated restructuring of loans, in part due to the fact that once the loans originating lender sells the loans, the lenders ability to restructure is eliminated.

The servicer or trustee is limited by the wording of the securitization documents and if the loan is part of a "Real Estate Mortgage Investment Conduit" or REMIC, it cannot be modified unless it has been delinquent for a certain period, in which case a modification may be available according to REMIC statutes. This type of modification would need to be supported by a legal opinion (translation, legal fees incurred by the servicer) and this could impact the servicers interest in doing the modification since it could lower or wipe out servicing income.  Until legislation exists to limit the liability of servicers attempting to modify pooled loans or mandating participation in losses by investors, getting a modification on a pooled loan will be problematic.

Two other key obstacles to a successful loan modification are:

If you need to sell in a healthy real estate market you simply list and sell your property, often at a profit. When markets soften or turn and a quick sale is not possible, a borrower needs to consider all "Loss Mitigation" (LM) strategies in order to minimize losses and expenses.

"Loss Mitigation" is the process of moderating or reducing losses related to mortgages used by lenders and servicers. Loss mitigation includes many strategies other than Loan Modification Agreements.

Loss mitigation programs were established by the federal government and the mortgage industry in order to reduce or stop home foreclosures. They help foreclosure victims in default on their mortgages to find alternatives to home foreclosure. Every homeowner’s situation is unique and each lender has their own policies regarding the use of these programs to stop foreclosure.

1. Loan Modification
(Available on a very limited number of VA loans with lender and/or investor approval) (Called Recast for FHA)

If you have incurred a long term financial hardship, an LMF can assist you in supplying the appropriate information to lender to take the appropriate measures to modify the term(s) of your mortgage. This could lower the interest rate and/or extend the term of the loan resulting in lower payments. There are costs and fees associated with a modification that you will be responsible for. All property taxes must be current or you must be participating in an approved payment plan with your taxing authority to be eligible for a modification. Any additional liens or mortgagees must agree to be subordinate to the first mortgage. All requests are subject to your lender’s approval.

2. VA Loan Modification/Refunding
(Available for VA loans only) (Need at least 30 days to process)

A refunding is when the VA buys your loan from the lender. Refunding may give VA the flexibility to consider options to help you save your home that your current lender either could not or would not consider. When the VA refunds a loan under 38 U.S.C. 36.4318, the delinquency is added to the principal balance and the loan is re-amortized. Your new loan will be non-transferable without prior approval from the Secretary. If your interest rate was lowered and an assumption is approved, the interest rate will be adjusted back to the previous rate.

3. Short Payoff
(Short Sale) (Pre-foreclosure Sale) (Compromise of Sale)

If you have suffered a long term financial hardship and are unable to maintain your loan or if you need to sell the property to avoid a default loss on the property, it is possible that the lender may be able to accommodate you with a short payoff. A qualified buyer is required. If this is an option you wish to pursue, you must inform the loss mitigation specialist assisting you immediately. There may be tax ramifications associated with any short payoff or foreclosure; therefore, we recommend you contact your tax advisor for details.

See your state’s foreclosure laws for more information and check with an attorney for advice on your personal situation. There is information on debt forgiveness at the IRS Website at: www.irs.gov/individuals/article/0,,id=179414,00.html .

If you have incurred a long term financial hardship and your house has been on the market (at fair market value) for at least 90 days, you may be eligible for a deed-in lieu of foreclosure. To be considered for this option, you must complete a financial package for your lender and provide a copy of your recent active listing agreement. Also, there cannot be any additional claims or liens (other the mortgage) against the property. If you are approved for a deed-in-lieu, you will be giving up all rights to the property and the property will be conveyed to your investor. In exchange for the deed-in-lieu, the lender may waiver all deficiency judgment rights. You may be asked to participate in a Short Payoff program before a deed-in-lieu of foreclosure is accepted.

If you have incurred a short term financial hardship and your loan is two or more months past due, your loss mitigation specialist will also consider submitting a request for a payment plan to your lender for approval. Only after reviewing your financial situation will this option be considered. All clients must be able to show that they can afford this plan in order to be eligible.

6. Forebearance

Forebearance involves a repayment plan that is based on the borrower's specific financial situation. The plan may include a temporary reduction or suspension of payments for a specific length of time. Forebearance may be offered/used when the borrower has a reduction in income or increase in expenses that is not expected to be permanent typically a job loss or illness. Forebearance is most likely to be offered on loans from a portfolio lender.

7. Special Forebearance
(FHA loans only) (Type I & II)

If you have incurred a short term financial hardship and your loan is 90 days to 365 days past due, the loss mitigation specialist will also consider submitting a request for a special forbearance. A special forbearance is designed to provide you with more relief than is possible with a regular repayment plan. Typical approval can result in spreading the repayment over 12 to 18 months. Type II – can be utilized in an unemployment situation whereby the promise of future employment is present. We have done VA loans that resulted 27-month repayment plans.

8. Partial Claim
(FHA mortgages only) (Some Freddie Mac Investor loans)

The loss mitigation specialist may assist in requesting a partial claim if you qualify. You may be eligible if your loan is 120 to 365 days past due. A partial claim results in placing your past due payments into a subordinate mortgage (2nd mortgage) between you and the Secretary of Housing Urban Development. The partial claim note will require you to start making payments when you pay off the first mortgage. There is no interest. The partial claim can be for no more than 12 months of past due payments.

This is an arrangement where a qualified borrower agrees to assume responsibility for repayment of the mortgage from the existing borrower. Again, the most likely case for this scenario is a portfolio loan.

Conclusions

As you can see the challenges to loan servicers in particular are significant and represent significant obstacles to borrowers seeking a loan modification agreement. Keep in mind that obtaining a modification is not impossible and if you are successful you keep far more than you lose.

The highest probability for the successful negotiation of a loan modification comes from the following three scenarios:

For an owner occupied primary residence where the first and second mortgages are with different lenders, or with a servicer or trustee, the chances of a modification are greatly reduced but not eliminated. If a modification is negotiated, it is likely to be in the form of a lower "interest only" rate for a specified term on a first mortgage. This may be enough for the borrower to keep the property.

If a non-owner occupied property needs a modification, success will depend on the financial condition of the borrower and the policies of the lender and every lender is different. Ultimately only the borrower can decide if the effort to get a loan modification is worth the time and the cost either as a DIY effort, or when using a Loan Modification Facilitator.

Loan servicers typically have software that integrates the guidelines for modifications of each mortgage pool they service for investors. The question is can a borrower working on their own compel the lender to share this information? It could also happen that the guidelines in the pool that hold your particular loan won’t allow a modification to be made or limit the number of loans in the pool that can be modified. Lender software also compares the Net Present Value (current cash value) of a loan modification to all available loss mitigation options and the software generally recommends the option with the highest Net Present Value.

Right now the policies and guidelines for each lender, servicer and trustee vary region by region and even office by office at each lender/servicer/trustee.

There is no controlling Federal Guideline for loss mitigation efforts by financial institutions and financial institutions are fighting the implementation of any significant regulation in this area tooth and nail. HR 5679, The Foreclosure Prevention and Sound Mortgage Servicing Act of 2008 would prohibit the initiation of a foreclosure if the mortgagee or servicer has failed to engage in "reasonable loss mitigation activities". This is a very consumer friendly bill and it will fail without huge public consumer support. You can see what is happening at on this bill at: www.house.gov/apps/list/hearing/financialsvcs_dem/hr041608.shtml as consumers, this bill deserves your support. If this bill fails, consumers need to scream for meaningful legislation to succeed it and vote out politicians who listen only to well-heeled constituencies.

If you are in financial difficulty and believe that you will soon be unable to make your regular house payment, do not wait until you are delinquent to contact your lender.

According to a recent survey for Freddie Mac by Roper Public Affairs, the top reasons that people do not call their lender are:

Steps you can take with a lender or servicer:

By now you understand that not every potential foreclosure situation can be resolved favorably, but the harsh reality is that lenders and servicers do not want more property. If you cannot seem to get anywhere in your negotiation, try asking them where to send the keys. Of course if you do this, you may need to be prepared to send them the keys. Many times this strategy will result in your file being "kicked upstairs" to someone with more authority to resolve issues.

The process of negotiating a loan modification with a lender is an adversarial one. Your lender is not your friend and will use the information you give them against you when it is to their advantage to do so. Being represented by a professional LMF can reduce this possibility, but you will have to pay at least a portion of the fees involved up front and there may be additional fees once the modification offer has been obtained.

(Editors note: President Obama has designated significant funds to save homeowners from foreclosure, however it appears that this legislation will have limited impact on upside down borrowers in CA, NV, FL or AZ.

Details on this program are due on March 4, 2009 and I will be discussing them on my blog at http://unsustainabubble.com .