In 2007, there was a recognition that the U.S. economy was slowing, but few predicted the severity of the recession that followed. The unemployment rate continued to increase and many Americans suffered a decrease in spendable income. Whether the decrease was due to reduced investment income or to loss of job, for the first time many borrowers faced the difficulty of meeting their debt obligations, including residential mortgage payments, while at the same time, watching the value of their home significantly decrease.
Not only did many residential mortgage borrowers face the potential of homelessness, but mortgage bankers also had concerns, because they wanted repayment of their loans, not a portfolio of foreclosed and vacant real property to manage.
Prior to 2007, there were few options for borrowers who defaulted on their loans, but the financial crisis resulted in the creation of various alternatives – some which allowed a borrower to exit the property, but many which offered an alternative to a borrower to retain ownership of the home. Government and lender modification programs allowed a change in the terms of the loan, such as interest rate reductions or a change in the time permitted for repayment of the loan. These modifications programs were intended to allow people to remain in their homes when they were facing a significant hardship. Although modifications permitted immediate relief in home-retention, there continued to be questions as to whether these tools worsened the borrowers’ future opportunities and investment goals.
As the financial horizon began to improve, these modification programs continued to evolve, but the federal government modification program known as HAMP (Home Affordable Modification Program) expired on December 31, 2016. Additionally, for the second time in two months, Fannie Mae and Freddie Mac announced that they are increasing the interest rate for standard mortgage modifications – the highest that it has been in 18 months. Foreclosure activity has dropped significantly and is at the lowest level of filings since 2006.
Does this mean that the loan modification has disappeared from a lender’s toolkit for consumers facing impending delinquency? The answer is that there will always be a need for loss mitigation tools, including the loan modification, due to unexpected life events that borrowers face; however, the options are decreasing.
Historically, the delinquency rate for prime fixed-rate mortgages was 1-3% (slightly higher for adjustable-rate mortgage) until the financial crisis in 2007, when delinquency rates increased. By the end of 2016, the mortgage delinquency rate significantly decreased.
Even with the reduced delinquency rate, there will continue to be borrowers with past due loans who seek some type of loss mitigation where they can retain their home. Many investors and lenders continue to have proprietary modification programs – some of which have terms similar to HAMP – to aid borrowers in resuming affordable mortgage payments and bringing the loan to a current status.
Proprietary modification programs of lenders vary, but the most common features include one or more of the following:
>>Temporary or permanent interest rate reduction;
>>Extended payback period (up to 40 years); and
>>Deferral of principal (usually at zero interest).
More rare is a modification that includes principal reduction or forgiveness of debt. This option is often limited by contractual obligations related to mortgage-backed securities. Additionally, such forgiveness of debt can result in unexpected federal income tax obligation for the borrower.
Often overlooked for FHA loans, The Department of Housing and Urban Development (“HUD”) offers a program known as the partial claim mortgage, which is beneficial to the borrower, as well as the lender. A borrower who has experienced an event that caused the delinquency (such as reduction in income due to job loss or a medical event) may be in a position to resume regular monthly mortgage payments, but unable to pay the unpaid delinquent amounts. The partial claim mortgage enables the borrower to have a fresh start, while deferring payment of the past due amount.
Under the partial claim mortgage, the borrower’s loan is modified, whereby it is split into two separate loans:
>>The original FHA loan payable to the lender is reduced by the past due and unpaid amount; thus, bringing that loan to a current status; and
>>The past due and unpaid amount is reflected in a new zero-interest note executed by the borrower and payable to HUD, along with a new mortgage to secure the repayment of the note (payment is not due until the original FHA loan is paid off or the borrower conveys the property to another party).
The partial claim mortgage allows a borrower to retain his home and resume making regular monthly mortgage payments, while deferring payment on the past due amount. The partial claim also benefits the lender, because the lender simultaneously files a claim with HUD and receives payment for that past due amount, by which the original loan is reduced. The borrower is able to resume his normal schedule of payments and the lender does not wait until loan payoff for repayment of the past due amount.
In certain circumstances, the HUD partial claim program is available to borrowers who have previously utilized the program; thus, it is possible to have two partial claim mortgages associated with one FHA loan. The HUD handbook and guidelines set forth the requirements for a partial claim mortgage, whether it be the first partial claim or a subsequent one.
Although some programs are ending or changing, loan modifications are not gone; these tools in some form continue to be available for borrowers. Nevertheless, there will continue to be differing opinions and discussions as to whether (1) the government (state or federal) should be involved, and to what extent, in consumer financial matters, including residential mortgage loans; and (2) whether loan modifications are only a short-term fix that ignore the long-term investment consequences to borrowers.
About The Author
Lisa Minkoff’s law practice is focused on the ins and outs of mortgage banking regulatory compliance, residential real estate transactions, and residential title insurance. She has served as in-house counsel for title insurance companies and banking institutions, where she advised on both mortgage origination and mortgage servicing.