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Loan Modifications: Salvation Or Scam?

Financially challenged property owners have become a huge target for scam artists. Loan modifications can be especially risky. As a responsible Realtor, what can you do to protect your clients?

Julie Harris, who trains Realtors on how to assist homeowners with the loan modification process, was recently interviewed. At the National Association of Realtors’ midyear conference, the speakers on risk management insisted that Realtors who do loan modifications are illegally practicing law — it is a practice to be avoided. Instead, they said clients should be referred to the lender, to a reputable loan modification company, or to an attorney.

In contrast, Harris shared a number of ways that Realtors can legally assist their clients in navigating through the loan modification process and, in some cases, be paid for their efforts.

Whether you are compensated or not, helping someone keep their home is the right thing to do. It can also create tremendous viral marketing for your business. The typical adult in the U.S. knows about 250 people, on average. Given that each of those people also know hundreds of others, thousands of people could hear what you did to help a desperate family keep their home.

Before determining if working with loan modifications is right for your business, it’s important to understand some basic principles.

1. Loan modification myths
According to Harris, a common myth is that loan modifications are limited to FHA loans. This myth apparently began when the Obama administration issued guidelines for Freddie Mac- and Fannie Mae-owned or serviced loans. The truth of the matter is that you can modify any type of loan whether it’s a jumbo, fixed-rate, adjustable-rate, FHA, HELOC, etc. You can also modify just the first mortgage, just the second mortgage, or both. In many cases, the issue is the second mortgage, which is often at a higher rate. Harris reports that second mortgage holders are becoming more willing to do loan modifications, often because they will receive nothing if the first mortgage holder forecloses.

Another myth regarding loan modifications is that the seller must be delinquent. Harris says that to qualify for a loan modification, the seller needs to show “the desire to stay and the ability to pay.” Sellers must also demonstrate financial hardship. This can take the form of a hardship letter (some examples of hardship letters).

2. FDIC and FHA guidelines for loan modification
In addition to demonstrating hardship, the owner must also meet the lender’s qualifying ratios. To make this determination, lenders use a HTI ratio (housing expense to income). The HTI ratio calculation is straightforward: HTI equals net housing expenses divided by total gross monthly income. Total gross monthly income includes the person’s base salary and excludes overtime or bonuses.

The maximum housing expense to income (HTI) ratio varies based upon whether the loan is an FDIC- or FHA-insured loan. The current FDIC guidelines vary between 31-38 percent. FHA guidelines recommend 29 percent. If lowering the interest rate doesn’t produce the appropriate HTI ratio, then the next option is to extend the term of the loan, typically from 30 years to 35 or 40 years.

Sometimes the lender will consider a principal reduction. According to Harris, only 1.8 percent of all loans received a principal reduction during the first quarter to 2009. The lender is under no obligation to provide a principal reduction, only to “consider” this as an option.

To see how this process works, has online software that illustrates the differences in the FDIC and the FHA models. By quantifying how much the lender will net by doing a loan modification vs. a foreclosure, the Quantrix tool allows lenders to determine which option provides them with the best return.

3. How lenders structure loan modifications
Harris explained that a typical scenario for a loan modification involves an owner who has a mortgage with a 7 percent or 8 percent interest rate. The owner is struggling to make payments and may have had several late payments. Provided that the lender agrees to the hardship and the loan modification request is packaged correctly, the lender may reduce the interest rate to 3 percent for the first three years.

In year four, the rate increases to 4 percent, in year five to 4.5 percent, and then becomes a fixed rate of 5 percent at the beginning of year six through the term of the loan. The lender waives all late fees and prepayment penalties. Arrears are added to the loan balance.

A slightly different scenario involves an owner with a high-interest-rate loan (12 percent or more). The lender agrees to reduce the interest rate to 3.5 percent for five years. The loan then adjusts to 5.5 percent for the remaining terms of the loan.

Helping consumers work through their problems can generate referrals. Is it also possible to earn money from doing loan modifications? See next week’s column to learn more.