How to Get a Loan Modification, Never Pay Up Front

There have been countless changes in the loan modification industry since in began en force circa 2007. Most importantly was the systematic weeding out of fraudulent service providers who set up shop to take advantage of distressed homeowners by charging a fee up front an never doing any work. I’ll say this now and repeat it again as it’s the single most important bit of information you should know when seeking a loan modification: NEVER PAY UP FRONT FOR A LOAN MODIFICATION!

Who can negotiate a loan modification?

You – that’s right. Although it can be to your benefit to have a professional help you through the process, there is nothing preventing you from attempting a loan modification on your own.
Foreclosure Consultant – These individuals are typically non licensed professionals and can either be for profit or non-profit companies. After July 1, 2009 in the state of California, all foreclosure consultants must be registered with the Attorney General’s office and post a bond in the amount of $100,000 (California Civil Code section 2945.45).
Attorney – Any attorney licensed in the state where your pending foreclosure is located. You can find all registered attorney’s by searching
Real Estate Broker or Agent – The most common source for advice and help negotiating a loan modification or short sale. Although not all real estate agents have the experience to qualify as experts in the field, they are allowed to help if they hold a current real estate license. You may find out if your agent or broker is licensed at the California Department of Real Estate website

Protect yourself from loan modification scams. How to spot foreclosure fraud.

In case you didn’t catch this in the first paragraph, NEVER PAY UP FRONT FOR A LOAN MODIFICATION! In California this practice is illegal. It’s also important to remember that if it sounds too good to be true, it probably is. Just like a stated income loan with a “starting” interest rate that is unexpectedly low, a loan mod with terms that don’t pass the sniff test are also unlikely to prove true.

I’ve listed below some of the more common loan modification scams for you to review and catalog:

I’ll again start with the loan modification counselor who asks you to pay a fee BEFORE you’ve successfully obtained a PERMANENT loan modification. I’ll say it again, NEVER PAY UP FRONT FOR A LOAN MODIFICATION!
The foreclosure consultant who tells you to make your monthly payments to him/her rather than your bank during the loan modification process. This should never happen.
The consultant who poses as a government affiliated entity. Often using names that sound like they are government related and asking you to pay them up front to qualify for one of the special government related programs like HAMP or HAFA. These groups will suggest that their company is directly linked to the program and they charge you to confirm you are eligible. Your lender will tell you if you are eligible for HAMP free of charge. You may also see the HAMP waterfall below.
Bait and switch “rescue loans.” It is imperative that everyone read and fully understand what they are signing. Bait and switch rescue loans will ask the homeowner to sign over title to their house to a third party in exchange for a new modified loan with a lower loan balance. Again, if it sounds too good to be true…
Rent to Own and leaseback schemes. Be aware of who you are dealing with and take care not sign over title to persons or companies who ask you to sign over title promising to sell the property back to you once the process is complete. These schemes may also include asking the homeowner to move out during the process, allowing the “consultant” to collect rent until the house ultimately goes to foreclosure sale. In this case the consultant never completes the modification, rather, they just postpone the foreclosure allowing them to collect rent for a longer period.
A late add to this list, from the CA Attorney General press release, beware of forensic loan audits. In this scenario the consulting company uses the forensic loan audit as a means of getting the homeowner to pay up front for the tools needed to complete their modification; in this case a forensic loan audit. Once the fee is paid, no work is done and the loan modification never happens.

What to be aware of going in. What are your chances of success?

The foreclosure process is stressful and often times overwhelming. In many cases home-owner’s are willing to suspend reality, try anything and trust anyone who promises to allow them to stay in their home. Fueling additional confusion in the loan modification process is the fact that many defaulting homeowners used stated income loans to refinance or make their purchase. Every homeowner should know before going into the loan modification process that you must have income to qualify for a loan modification.

This is worth repeating: If you cannot document income sufficient to pay your mortgage (that is a new lower mortgage payment), you will not get a loan modification! Further, although the bank may have taken your word for it when you qualified to take out the loan, they will require you document and will definitely confirm your income before agreeing to modify your loan. Generally speaking the goal of a loan modification is to lower your monthly payments to an amount equal to 31% of your current gross income.

Banks also require you have a hardship before seeking a modification. Examples of generally accepted hardships are divorce, death of an income provider, loss of job or income, forced relocation for a job, or pending interest rate increase. They are not going to modify your loan because you’d like to refinance, if your current income supports the monthly payment.

Next, the banks expect you to spend your savings before they consider modifying your loan. Two things to note here; first some of your retirement accounts are off limits thanks to the ERISA laws, meaning the banks cannot go after or require you to liquidate them in order to make mortgage payments. Second, it is generally accepted that the banks will expect a home owner to have less than two and one half times their current monthly payment before they modify a loan. For example, if your monthly mortgage payment was $100 and you had $250 in your savings account (2 1/2 times your payment), the bank would expect you to use that money before they modify your loan.

One final note on this subject, think twice about applying for a loan modification simply to postpone a foreclosure or short sale. Almost anyone can get a temporary modification through their bank. The suggested reasoning here is that the bank is attempting to collect a bad debt, in order to evaluate their ability to collect banks will attempt to gather any and all financial information you provide to later collect on that bad debt. If you are falsely or hopelessly building a case for a modification by showing income and assets, that information may ultimately prove detrimental to your short sale negotiations.

Credit Default Swaps Incentivize Loan Servicers to Deny Loan Modification Requests

The Credit Default Swap market exploded over the past decade to more than $62 trillion just before the height of the recent financial crisis, according to the International Swaps and Derivatives Association. This is roughly twice the size of the U.S. stock market, which was valued at about $22 billion at the end of 2007, and it far exceeds the $7.1 trillion mortgage market.

What is a credit default swap?

In its simplest form, a credit default swap (CDS) is an insurance-like contract that promises to cover losses on certain securities in the event of a default. A CDS is supposed to operate just like a wind or casualty insurance policy, which protects against losses from high winds and other casualties.

Specifically, CDSs are privately negotiated, bilateral agreements that typically reference debt obligations such as a specific debt security (a “single named product”), a group or index of debt securities (a “basket product”), collateralized loan agreements, collateralized debt obligations or related indexes.

A Typical CDS Transaction

In a CDS transaction, a party, or “protection buyer,” seeks protection against some sort of credit risk. The protection buyer normally makes periodic payments – known as “spreads” – to a counter-party, or “protection seller,” with reference to a specific underlying credit asset (often known as the “reference obligation”). The issuer is known as the “reference entity,” which is often, but not invariably, owned by the protection buyer.

The protection seller typically:

(i) Delivers a payment to the protection buyer upon the occurrence of a default or credit event (often a triggering event that adversely affects the value of the reference obligation and/or the financial health and credit-rating of the “reference entity” or “reference obligor”), and

(ii) Provides collateral to the protection buyer to ensure the protection seller’s performance.

Most CDSs are in the $10-$20 million range with maturities between one and 10 years, according to the Federal Reserve Bank of Atlanta.

If a default or credit event occurs or the value of collateral provided to the protection buyer by the protection seller is deemed insufficient by the calculation agent (typically the protection buyer), the protection seller must make payments to, or increase the collateral held by, the protection buyer.
Alternatively, in the event that the reference entity defaults on its obligations related to the reference asset, the protection buyer may require the protection seller to purchase the reference asset for face value, or some percentage of face value agreed upon in the CDS agreement, less the market value of the security.

RMBS Servicers & Affiliates Buy CDS

CDSs not only impacted the securitization market on Wall Street and financial centers around the world, but also homeowners across the country that have been contemplating or seeking to obtain a loan modification. Before exploring the impact that CDSs may have on homeowners or their ability or inability to obtain a loan modification, as the case may be, this article shall first discuss the major players involved in the CDS market. This is important as most of the CDS market participants are also directly or indirectly involved with servicing of securitized residential mortgage backed securities (RMBS).

Major League CDS Players

Only a handful of the biggest and most elite financial institutions in our global financial village are engaged in the credit default swaps market. Federal law limits those who may participate in the CDS market to “eligible contract participants,” which are defined as and include institutional investors, financial institutions, insurance companies, registered investment companies, corporations, partnerships, trusts and other similar entities with assets exceeding $1 million, or individuals with total assets exceeding $10 million.

It should come as no surprise then that commercial banks are among the most active in the CDS market, with the top 25 banks holding more than $13 trillion in CDSs. According to the Office of the Comptroller of the Currency (OCC), these banks acted as either the insured or insurer at the end of the third quarter of 2007. JP Morgan Chase, Citibank, Bank of America and Wachovia were ranked among the top four most active commercial banks.

These banks also, directly or indirectly, serve in the capacity as mortgage loan servicers of residential loans, which are charged with the responsibility of collecting, monitoring and reporting loan payments, handling property tax, insurance escrows and late payments, foreclosing on defaulted loans and remitting payments.

Pooling and Servicing Agreements Restrict RMBS Servicers from Offering Loan Modification Agreements

The RMBS servicer’s ability to negotiate a workout is subject to a number of constraints, most notably the pooling and servicing agreement (PSA). Some PSAs impose a flat prohibition on loan modifications. Numerous other PSAs do permit loan modifications, but only when they are in the best interest of investors. In such cases, the RMBS servicer’s latitude to negotiate a loan modification depends on the PSA. Some PSAs permit modification of all loans in the loan pool, while others limit modifications to five percent (5%) of the loan pool (either in term of number of loans or aggregate gross loan amount).

PSAs often include various and sundry restrictions on loan modifications, including, for example, mandatory modification trial periods, specific resolution procedures, caps on interest rate reductions, restrictions on the types of eligible loans and limits on the number of modifications in any year.

The PSA is not the only limitation on the loan servicer’s ability to enter into a “workout.” For instance, sometimes the servicer needs to get permission for the workout of a delinquent loan from a multitude of parties, including the trustee for the securitized trust, the bond insurers, the rating agencies who originally rated the bond offering, and possibly the investors themselves (“Barclay’s Capital Research” 11). Thus, when the servicer of a pool of RMBS requires authorization to exceed the limits on its loan modification discretion, according to the PSA, the modification is generally neither cost-effective nor practically possible for the servicer to obtain the myriad of needed consents, especially for one loan amidst a huge pool of securitized loans. As a result, the request for a loan modification is summarily denied without even considering the factual underpinnings of the request or the dire circumstances the borrower’s are currently fighting to survive. This is shameful.