The altered payment is achieved by either lowering the interest rate, lengthening the term, or reducing the balance to be more in line with the current market value. In most cases, a combination of all three of these options are used to reduce the loan payment. There are other alternative ways to reduce a payment with a modification also, but they all center around the term of the mortgage, the payoff, and/or the interest rate.
Here is an easy example of how a loan modification can reduce the payment, using each of the three solutions above.
Method #1 – Reducing the interest rate
Lets assume the payoff balance is $200,000 and the current interest rate is 7.75% and the payment amount is $1,750. Lets also assume this person has 20 years left on a 30 year mortgage. The victim can no longer afford this payment because of a reduced household income. They can afford a $1,250 payment, so the lender agrees to drop the interest rate to a fixed rate of 4.25% for the remaining life of the loan. This will give them a payment of $1,240, without the need to extend the term of the loan or lower the payoff amount.
Method #2 – Extending the term of the loan
Lets use the same example above, only this time, we'll assume the homeowner can afford a $1,500 payment. The loan amount will still be $200K and the interest rate will still be 7.75%. But in this scenario, the servicer was not able to drop the interest rate. This happens quite often, because the investors on the loan are not willing to accept a reduced rate. In this scenario, extending the length of the loan will make the payment affordable again and the investors will keep their 7.75% interest rate. The $200,000 payoff is re-amortized over a 30 year period to get a lower payment of $1,430. Everyone is satisfied because the foreclosure was prevented and the new payment is affordable.
Method #3 – Reducing the principal amount
In order for a principal amount to be dropped, the value of the home must be less than the payoff amount. In a few cases, servicers will reduce the payoff amount without this stipulation, but it's unlikely. To get the payoff amount dropped, you must prove to the lender that foreclosing on the home will cost more than lowering the balance to make the loan affordable again.
In this scenario, we'll assume the home's current market value has been verified at $179,000, but the amount owed is still $200,000. If the bank forecloses on the home and tried to re-list it, their estimated loses will be 30% of the home's value. So after foreclosing on the home and re-selling, they will get around $125,000, if they are lucky. Most banks expect to lose 30%-60% on every foreclosure property, so this estimate is being very generous.
By allowing the existing owner to keep the home, with a new affordable payment, they can continue servicing the loan and collect the full value, plus interest. This is a much better option for the lender, assuming the new payment is affordable. By reducing the payoff to $179,000 and keeping the same interest rate and 20 year term, the new payment is $1,470, which now fits into the homeowners $1,500 budget.
Applying All Three Choices At The Same Time
When dealing with my cases, I often try to get the lowest possible payment, which would mean lowering the interest rate and payoff, while lengthening the mortgage to 30 years. By negotiating all of these figures, a new payment of $880 could be fixed for the remaining term of the loan. An experienced loan modifier knows exactly how to get the lowest possible payment in the shortest amount of time.
Negotiating with lenders is all a matter of having the right information and being prepared. It's not something most homeowners can accomplish without help, regardless of what many people may think. A loan modification is the answer to keeping and affording your home. Arguing your case wrong can not only cost $1000's but it can cost you your home!
In the previous example, the difference between a good modification and a bad modification adds up to over $100,000 in extra payments over the life of the loan! So even if you are successful with a modification on your own, it could still cost you over $100,000! If you don't have experience with what you're doing, or don't have confidence in your ability to get an affordable payment, make sure you hire someone to help immediately. There is no time for "gaining knowledge from your mistakes" when a single error could cost you your home!
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By: Nick Adama
Nick publishes articles on the ForeclosureFish website to provide foreclosure help and information to homeowners in need of assistance. The site examines various ways to save a home, including deed in lieu, filing bankruptcy, short sales, defending foreclosure in court, and more. Visit the site for an e-book explaining the basics of foreclosure and how to stop the process: www.foreclosurefish.com/
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