Will a Loan Modification work for me?

Here is some information that may help you understand how your modification request may be analyzed.

Housing Expense Ratio:

The housing to income ratio includes expenses that are part of the recurring housing expense. The housing expense usually includes payments on all mortgages, taxes, insurance, HOA dues, and ground rent. However, some lenders and programs will not include payments on subordinate liens and mortgage insurance in the housing expense ratio. Under the Making Home Affordable program, payments on subordinate liens and mortgage insurance are not included in the housing expense ratio. Its important to know whether the lender is including subordinate liens in the housing to income ratio because it can have a material impact on qualifying for a loan modification..

Total Expense Ratio:

The total debt to income ratio includes the housing expense and recurring liabilities for revolving and installment debts, bankruptcy payments, tax liens, mortgage payments for second homes, and alimony and child support. Some lenders and programs might include payments on junior liens and mortgage insurance in the total expense ratio instead of the housing ratio. Negative rents and business losses are usually deducted from gross income. Expenses for regular payroll taxes, personal insurance, dependent care, food utilities, commute and medical expenses are usually excluded from the debt to income calculation.

The debt to income ratios are calculated by dividing monthly housing and total expenses into the gross income.

Example of How to Calculate Debt to Income Ratios:

Monthly Gross Income: $5000
Monthly Housing Expense: $2100
Recurring Monthly Recurring: $800
Total Monthly Housing and Recurring Liabilities: $2900

$2100 / $5000 = 42% Housing to Income Ratio
$2900 / $5000 = 58% Total Debt to Income Ratio

Example if second trust deed of payment of $600 is not included in housing expense:

Monthly Gross Income: $5000
Monthly Housing Expense: $1500
Monthly Recurring Expenses: $1400
Total Monthly Housing and Recurring Liabilities: $2900

$1500 / $5000 = 30% Housing to Income Ratio
$2900 / $5000 = 58% Total Debt to Income Ratio

Most modification programs require a minimum housing ratio of 31% to 38% to qualify for modification assistance. The FDIC Mod in a Box and FNMA/FHLMC Home Affordable Program aim to reduce the housing to income expense to as low as 31%. As you can see, whether the payments on secondary financing and mortgage insurance are included in the housing expense can impact eligibility.

Disposable Income / Residual Income: This is the amount that is left over after subtracting housing expense, recurring liabilities, child care, commute expense, food, medical, utilities, insurances, taxes, and payroll contributions. If this number is a negative, get help immediately.

Understanding Loan to Value Ratio (LTV): Loan to value ratio (or LTV) is obtained by dividing the amount due on the mortgage into the current (or estimated) value of the property. Combined loan to value ratio (or CLTV) is calculated by combined the total amounts due on all liens and mortgages by the estimated value of the property.

Example for Loan to Value (LTV):

First Lien: $300,000
Property Value: $375,000

$300,000 / $375,000 = 80% Loan to Value (LTV)

Example for Combined Loan to Value (CLTV)

First Lien: $300,000
Second Lien: $50,000
Total Liens: $350,000
Property Value: $375,000

$350,000 / $375,000 = 93% Combined Loan to Value (CLTV)

Net Present Value Test (NPV Test):

A NPV test determines the net present value of a loan that is not modified and compares it the net present value of the loan if modified to determine which option provides the highest yield to investors. NPV tests are also referred to as Anticipated Recovery Tests.

Information on FNMA/FHLMC’s Making Homes Affordable NPV Test Model:

This model is used by FNMA and FHLMC in connection with the Making Homes Affordable Program. It is considered the gold standard for NPV tests by the mortgage industry. The model is based on present and future values of the loan if modified and if not modified factoring in the probability of default for each.

The model computes the present value of future cash flows assuming the loan isn't modified, projects the present value of future cash flows if the loan were to default, projects the present value of future cash flows assuming the loan does not default, then takes the weighted probability average of the two options.

The model then does the same computations assuming the loan is modified and compares the two present values to determine whether the NPV test is positive for modification. If the NPV test is positive, the lender must offer the borrower a modification.

The NPV model takes principal factors that can influence cash flows into consideration, such as:

• The value of the home relative to the size of the mortgage.
• Likelihood of foreclosure.
• Home price trends
• Cost of foreclosure
• Cost of modification

In addition to individual loan data, there are key perimeters that can vary from lender/servicer to lender/servicer. These are:

1. Discount rate: This is applied to present value calculations to determine the present value of future cash flows. For the Making Home Affordable Program, the discount rate can be based on FHLMC's Primary Mortgage Market Survey rate for fixed rate mortgages or as high as the the PMMS plus 250 basis points. However, for loans not guaranteed by FNMA/FHLMC, the servicer can apply their own discount rate based on either loans in its portfolio or loans serviced for others.
2. Default rates: The model projects the probability of default for the loan if modified and if not modified based on the credit quality of the loan and other variables. The default rates generated by the model are based on performance data on GSE and non-GSE loans. However, servicers can customize their default rates based on their own data. So this variable can get tricky.
3. Home Prices Projections: Servicers have to use the home price projections provided by the NPV model. The information on home price projections is provided by the FHFA.
4. REO Stigma: Because REOs typically sell for less, the model adjusts for the REO Stigma effect. REO Stigma values vary from state to state and home prices and cannot be modified by the lender.

As you can see, the model is complex and automated. It simply can’t be calculated by third parties manually. NPV tests use proprietary software with perimeters that may vary from servicer to servicer. My recommendation to borrowers who have been declined for a modification, is to request the results of the NPV test. If the lender didn't perform one or will not provide it, I would then advise the borrower to see an attorney.

When a Modification or Forbearance Will or Won’t Work:

Because of various program or lender requirements, a modification or other loss mitigation solution may not be offered. The reasons can vary, but this section will explore the most common ones.

Housing Expense/Total Expense Ratio: If the housing ratio is under 31-38%, a modification likely will not be offered. Also, if the total debt to income is over 55%, counseling with a HUD approved non-profit credit counselor is typically required. If the debt is excessive, the probability of repayment may be low enough to decline the request.

Insufficient Balance Left Over for Family Support: If the total monthly expenses including household expenses are too high to afford the mortgage payments, the request may be declined unless the budget is revised so that the borrower can afford the payment.

There are Sufficient Assets to Make the Payment: If there are assets that can be used to make the payment, the lender might not approve a modification request until the assets are exhausted. Certain assets such as retirement accounts, emergency funds, medical funds, education funds, and certain business funds are typically excluded from available assets. If the request is declined due to the lender including these accounts, be sure and notify the lender why these funds cannot be assessed to make the mortgage payment.

Temporary Income: If income is of a temporary nature or there isn’t a regular source of income, the lender may not be able to approve a modification request. In this instance, the lender may be willing to offer a forbearance or other loss mitigation solution.

Insufficient Income: If the income is insufficient to support the obligation after interest rate reduction, extension of the loan term, principal forbearance, and/or principal reduction, a loan modification will likely not be offered. Make sure that all income from household members is used even if the household member is not on the loan.

NPV Test is Negative: If the lender’s NPV test is negative, it means that the loan has a higher net value in event of default than if the loan were modified. If the value used by the lender is higher than the actual market value, its important to document the reasons why the lenders value estimate is incorrect. Because lenders are permitted to use less accurate means of determining property value such as BPOs and automated valuation methods, its important to make sure that the value isn’t overstated and all other information is correct. Once the issue is resolved, request that the lender redo the NPV test.

Loan-to- Value May Be Too Low: If the loan to value is too low, other options may be available to the borrower such as refinance or sale. If the property value is high and the loan to value is low, it is likely that the HPV test will be negative,

Excessive Risk: Another reason for a negative NPV test may be due to excessive risk which can be caused by the lender entering inaccurate data. Be sure to confirm the income, assets, and liabilities used by the lender to ensure the results of the NPV test are correct.

Temporary Hardship: If a hardship is temporary, the lender may opt to offer a temporary loan solution such as a forbearance or repayment plan.

No Hardship: There is no hardship and the borrower(s) have the ability to repay the loan.

Fraud Involved in Original Loan or Loss Mitigation Request: If the lender determines that fraud was involved in either the original loan or modification request, they might decline the request. If you were not aware of fraud on the original loan or modification request due to making the request through a broker or third party, advise the lender.

Bankruptcy: Although agency guidance has recently shifted toward proceeding with loss mitigation during bankruptcy, participation in certain programs while the borrower is in bankruptcy is currently left to lender discretion. If bankruptcy is a factor in the modification being declined, its important to communicate to the lender that the bankruptcy has alleviated a financial hardship and that reaffirmation of the debt is desired if a modification agreement can be reached.

Participation in a Debt Management Plan: Because private debt management plans can do substantial damage to credit and debt negotiations are uncertain, it is important to discuss whether switching to a HUD approved non-profit credit counseling plan may impact the chances for approval. It the lender indicates a higher probability of approval with a HUD approved program vs. the private plan, it is important to review the private debt plan contract for cancelation rights. In the event that the debt management company is not licensed, it may be important to seek help from enforcement agencies and/or an attorney to cancel the contract and receive a refund.

Occupancy: The property is not owner occupied. Most modification programs such as the Making Homes Affordable program are not available for non owner-occupied or investment properties. However, some companies will still choose to offer modification or other loss mitigation solution on non-owner occupied properties when it makes sense. Therefore, its important to insist with the request if an NPV test is positive for modification.

Note Holder Restrictions: Certain loans, such as non GSE securitized loans, may contain restrictions which limit modification of certain loan terms and other loss mitigation solutions. If the modification or other loss mitigation request is denied due to investor restrictions, request a copy of the loan pooling agreement and/or master servicing agreement to determine if the servicer is truly restricted.

These are just some of the reasons why a modification or other loss mitigation request may be declined. Again, its not an exhaustive list and only covers some of the typical reasons why requests may be declined.

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