Jul092014

The final resolution of loan modifications will push people out of their homes

As prices near the peak, lenders allow loan modification payments to reset forcing people out who can’t afford the payments.

loan-modification-rescindedLenders give loan modifications to desperate borrowers ostensibly to keep them in their homes, but more importantly for lenders, loan modifications keep properties off the MLS and force buyers to compete for diminished inventory driving prices higher; but once prices near the peak, will lenders be so accommodating to struggling borrowers?

Loan modifications are not an entitlement, and banks don’t want to make them one, but that’s not how borrowers see it. Borrowers consider loan modifications a birthright, and they believe lenders will always accommodate their sob stories and allow them to remain in houses they can’t truly afford.

Lenders hope they can sustain loan modifications until prices near the peak when lenders can rescind the loan modification entitlement, push the borrowers out, recover lender capital, and loan that money to someone who will pay in accordance with the promissory note terms. Lenders are in the business of loaning money and maximizing the return on their capital; they aren’t a charity providing lifelong subsidies to borrowers who want to remain in houses they can’t afford.

Many homeowners with loan mods face rate increases

Lew Sichelman, June 22, 2014loan_modification_denied

If you are one of the millions of once-desperate homeowners who have had their loans reworked by a mortgage company to avoid foreclosure, it’s time to start facing the possibility of having to do it all over again.

Beginning this year, those whose loan terms were modified so that the interest rate dropped to as low as 2% will have to deal with higher rates that could, in some cases, drive the monthly payment as much as $1,724 higher.

Why? Because “permanent” interest rate reductions under the government’s Home Affordable Modification Program were anything but. Whether participants realize it or not, rate reductions last for only five years. Consequently, the clock is ticking — especially for the earliest beneficiaries of the program, which was built to help underwater or financially strapped borrowers save their homes.

In my opinion, HAMP loan modifications will become permanent housing entitlements. The funding for HAMP came from money printed by the federal reserve, making foreclosure politically impossible. Can you imagine the political fallout when everyone realizes the federal reserve was the foreclosing entity trying to get back printed money?someone_you_should_meet

Moreover, countless others received modifications under lenders’ proprietary relief programs that were patterned after HAMP, which was created under the Financial Stability Act of 2009 as a collaboration among lenders, investors, mortgage servicers and Uncle Sam’s housing agencies to create standard loan modification guidelines.

The Urban Institute says the number of proprietary mods is “considerably higher” than the number of HAMP mods — perhaps five times higher, or something above 5 million.

Private loan modifications have even more onerous terms, as lenders benefit from loan modifications, but homeowners not so much. When those modifications reset, if the property is above water, the lender will not grant another loan modification. Private loan modifications are tomorrow’s distressed property sales.

And the number crunchers at Black Knight Financial Services point out that more than 40% of the 2 million borrowers who benefited from modified loan rates still owe more than their houses are worth. Moreover, the data and analytics firm says an additional 18% have 9% equity or less in their homes. (Borrowers with less than a 10% stake in their properties usually must bring cash to the table to pay loan fees and closing costs.)

Because so many are underwater, lenders are in no hurry to foreclose, and borrowers are in no hurry to list and sell their homes. Many who do list and sell suffer the loss of entitlement of stepping down the property ladder.

The emotional impact of ending loan modifications

The technical and political issues discussed daily on this blog only capture part of the loan modification issue. On a micro level, the lives of individual families are shaped in many ways, and the emotional impact of falling from entitlement is very real. Today, I want to revisit the story of a loanowner family and consider what lies in store for them.pay_our_debts

Some time ago, I had an extended conversation with a loanowner. He bought eight investment houses during the housing bubble in addition to his primary residence in 2005. He didn’t put any money down, and he used option arms for most of the purchases, including his primary. When the bust came, he let the eight properties fall into foreclosure, and he stopped paying on his primary mortgage in order to qualify for a loan modification, which he got. Everyone else living in a primary residence as opulant as his pays about $4,000 a month for the privilege; his loan modification payment is about $2,000 per month.

Like homeowers, this loanower family is emotionally attached to their house. Even though they haven’t had a true equity stake in the property in the nine years they’ve owned it so far, they feel like they “own” it because their name is on title. They want to keep the house because they consider it their family home, customized to taste. They don’t want to move, and if given the chance, they will stay in their family home.

One of the reasons many loanowners don’t want to sell is because they will endure the unceremonious fall from entitlement. People who can’t afford their homes are living beyond their means, as evidenced by the loanowner qualifying for a $2,000 monthly payment on their $800,000 mortgage. If they sell and find a rental, they will be forced to live within their means in a property they can afford. For most loanowners, that means taking a step down the property ladder, and nobody wants to do that. So unless they are forced to, these loanowners won’t voluntarily sell a nice house to move into one they consider substandard. When combined with the emotional attachments of home ownership, most people will chose to struggle and fight rather than capitulate and sell.

Second, this loanowner wasn’t being compelled to sell due to the cost. With his loan modification, his monthly cost of ownership is lower than a comparable rental. With his 2% temporary teaser rate, his payment is very low. As long as his monthly costs are lower than a comparable rental, it doesn’t make sense for him to sell and rent.Ponzi_wine

When I asked him what happens when his interest rates starts to rise back up to the contract rate, he said one of two things would happen. Either he would be offered another loan modification, or he would be able to refinance into a low-interest rate mortgage — not going to happen.

It’s not very likely he would be offered another loan modification unless the property were still severely underwater. The serial refinancing of one teaser rate to another died with the collapse of the housing bubble. Banks are willing to deal now because the property has no collateral backing, but the loan modification entitlement will be rescinded as prices near the peak.

If a loanowner has equity again, even a tiny amount of it, and the terms of the loan modification increases the borrowers costs, the borrower can ask for another loan modification, but it’s unlikely they would receive one. Why would the bank cut them a deal once they bank can get paid in full from a sale? It would be better for the bank to force the old owners out in favor of a new one who will pay the full current rate on a home loan.

Basically, he is in denial. He is living on borrowed time, renting from the bank, and reacting to temporary circumstances and hoping something will work out. Right now his incentive is not to sell, so he doesn’t. However, his cost of living will continue to escalate over the next few years, and as the value of his property is nearing the amount he owes, the rising cost of his housing will ultimately push him out.

The family reacts to a denied loan modification

The following is a fictional account of a conversation yet to take place between Entitled, the loanowner’s spouse, and Prudence, the friend whose family avoided the housing bubble. The details will be different from case to case, but variations of this conversation will play out with millions of families over the next several years as prices near the peak.rejected

Entitled: The bank rejected our request for another loan modification. I think we are going to have to sell the house.

Prudence: That’s a shame. Those bankers are so evil.

Entitled: We’ve lived in that house for 12 years now. It’s our home, and the bankers are forcing us to leave.

Prudence has a fleeting thought about the bad choices Entitled’s husband made but chooses to remain silent.

Prudence: Well, you and your family got to live in that beautiful house for 12 years, raise your daughter, and it only cost you about $2,000 per month, right?

Entitled: It’s our house. After 12 years living there, it’s not fair that the bank can ask for more money for us to keep it.

I_rented_housing_bubblePrudence and her family didn’t buy a house during the bubble. Instead, they rented a small two-bedroom condo and bought an affordable condo near the bottom. She and her family have been living within their means, but in much less opulent circumstances, and they’ve been paying the same monthly housing expense as Entitled. This fact enters Prudence’s thoughts, but she is there to comfort her friend, so she says nothing about it.

Prudence: Are you going to be able to sell for enough money to buy another home?

Entitled: We barely have enough equity to pay the sales commissions, and although our credit is better than it was, I don’t think we will be able to afford a nice home. We may try to buy a condo, but it’s such a step down, we won’t be happy about it.

Prudence feels the slap in the face of her friend’s sense of entitlement. She suppresses her anger, but the look on her face betrays her. Entitled catches the expression in her friend’s face and realizes what she said, but she’s so caught up in feeling sorry for herself, she can’t bring herself to apologize.

Prudence: I’m sorry the loan modification didn’t work out for you permanently, but when you get a new place you can afford, you will be able to keep it as long as you like.

Entitled: We don’t want a new place; we like the one we have. It is perfect. It has four bedrooms and a loft. We can have visitors and a play area for our daughter. It is our dream home, and the banker is making us leave it.

Prudence thinks to herself, “We’ve been living in apartments and small condos for the last 12 years because it is what we could afford. A big, beautiful house like yours would have been great, but the stress of living beyond our means wouldn’t have been worth it. But then again, Entitled got to live in that house for 12 years. I wonder if she made the better choice? Twelve years is a long time.give_it_back

Prudence: Do you regret living in such a nice house for the last 12 years? It seems like the bank made you a pretty good deal, at least while it lasted.

Entitled: While it lasted? This was supposed to be our “forever house.” When we bought it, we thought we would make a fortune from appreciation to fund our retirement. We believed would be able to refinance into a low payment in a couple of years and keep that house forever. All the promises the lenders made us turned out to be lies, including the part about our loan modification being “permanent.” I hate bankers.

Prudence thinks that she hates bankers too. They lobbied Congress for huge bailouts, taking Prudence’s money to pay themselves obscene bonuses and bail out loanowners like Entitled.

Prudence: Yea, those bankers are assholes.

Entitled: Those assholes should make our loan modification truly permanent so I can keep my house.

Prudence thinks the bankers were assholes to let Entitled keep her house as long as they did, but rather than be rude to her friend, she fakes a tight smile and nods her head in agreement with Entitled.

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