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Mortgage Servicing and Loan Modifications: 6.2.4.5 Principal Forbearance

Often a loan modification may involve forbearance of part of the capitalized principal balance; that is, repayment of a portion of the principal is delayed until the loan is paid off in full. The forborne principal becomes a balloon payment, and interest is not charged on the forbearance amount. Principal forbearance is usually the last in a series of steps that servicers employ to reduce the monthly payment.

Mortgage Servicing and Loan Modifications: 6.2.4.6 Forgiveness of Principal or Arrears

Less common than principal forbearance, but still an option, is the forgiveness or cancellation of a certain portion of the principal balance or interest arrears. Principal forgiveness may be most common when the loan amount exceeds the value of the property due to depreciation. It also may be offered as part of a negotiated resolution of litigation or settlement of potential legal claims.

Mortgage Servicing and Loan Modifications: 6.2.5 Deferrals and Partial Claims

For homeowners who have recovered from financial hardships and can afford their pre-default mortgage payments, some investors have made payment deferrals available. Deferral programs generally bring the mortgage loan current by making any unpaid arrearage due as a lump sum at the end of the loan term, which may be at the sale or refinance of the loan. The borrowers then resume their former mortgage payments. These deferral programs generally do not charge interest on the deferred amounts and do not require monthly payments on the deferred balance.

Mortgage Servicing and Loan Modifications: 6.2.6.1 Short Sales

Some mortgage holders, particularly in a depressed real estate market, may agree to allow property to be sold through a realtor rather than foreclose, even if the proceeds of the sale will not cover the amount due on the mortgage. This is called a “short” sale or “pre-foreclosure” sale. A short sale may help the mortgage holder avoid a portion of its potential foreclosure losses. The sale also avoids a foreclosure notation on the homeowner’s credit report.

Mortgage Servicing and Loan Modifications: 6.2.6.2 Deeds in Lieu of Foreclosure

It may be possible to negotiate to have the mortgage holder accept voluntary transfer of the property as an alternative to foreclosure. This is usually called a “deed in lieu of foreclosure.” Deeds in lieu of foreclosure will not be accepted by the mortgage holder if there are junior liens on the property, because in that case foreclosure is necessary for the mortgage holder to obtain clear title.

Mortgage Servicing and Loan Modifications: 6.3.1 Bankruptcy

The best alternative to a voluntary workout from the creditor is often a chapter 13 bankruptcy filing. If workout discussions are commenced but proceed unfavorably, the chapter 13 bankruptcy option remains available for exploration up until the time of sale. Moreover, borrowers can continue to apply for loss mitigation options while they are in an active chapter 13 or chapter 7 bankruptcy proceeding.

Mortgage Servicing and Loan Modifications: 6.3.2 Refinancing

If the home was financed at a high interest rate, refinancing at a lower interest rate and/or with a longer payment period can greatly reduce monthly payments. Moreover, if the borrower can obtain a good rate, refinancing a low interest first mortgage and high interest second mortgage into a low interest first mortgage can also reduce payments.

Mortgage Servicing and Loan Modifications: 6.3.4 Selling the Home

When a property can be sold for more than the balance owed on the mortgage, the loan will be fully paid from the sale proceeds. This is typically known in the industry as a “full” sale. The proceeds of the sale that exceed the mortgage balance are retained by the homeowner.

Mortgage Servicing and Loan Modifications: 6.3.5 Mortgage Assumption

Some mortgages can be freely assumed (taken over) by a third party. When a mortgage is freely assumable, the property can be transferred, and the person to whom it is transferred can step into the shoes of the borrower. The desire to assume a loan on the part of a transferee often coincides with a financial hardship and default on the payments. However, absent a modification or some other workout agreement, the person assuming the mortgage in default will be subject to the same collection activity as the transferring borrower.

Mortgage Servicing and Loan Modifications: 6.4.1 Client Needs for Representation

Obtaining a loan modification or other workout option can be a complex process, fraught with confusing guidelines, daunting paperwork, and servicer recalcitrance. Homeowners on their own may grasp for any workout option offered, even one that will not work in the long term and may make matters worse. Even more damaging, homeowners can fall easy victims to foreclosure rescue or loan modification scammers.

Mortgage Servicing and Loan Modifications: 6.4.2 Preparation Tips

An important key to success is extensive preparation. Begin with a clear understanding of your client’s financial situation. Detailed information should be obtained about debts, income, assets, and expenses.62 Realistic income and expense projections are particularly important.

Mortgage Servicing and Loan Modifications: 6.4.3 The Client’s Objectives

As with any case, the client’s needs and goals must be fully explored. For example, clients experiencing temporary lay-offs may have a legitimate expectation of increased future income upon return to work. For them, a period of temporary forbearance on mortgage payments might be the most appropriate objective. Other clients, particularly older clients upon retirement, may have a permanent income reduction. They will require a permanent loan restructuring. Still others may prefer to sell their homes because of an expected permanent decrease in income.

Mortgage Servicing and Loan Modifications: 6.4.5.1 Generally

An understanding of the existing loan terms and the amount of the default is essential to a workout. Obtaining an itemized reinstatement quote broken down between principal, interest, escrow, late fees, and (specifically itemized) foreclosure fees and costs is also important. When the borrower has leverage, it is easier to negotiate forgiveness of interest than of legitimate costs like escrow advances expended by the servicer.

Mortgage Servicing and Loan Modifications: 6.4.5.3 RESPA Provision Requires Servicers to Provide Information About Loan Accounts and to Correct Errors

The Real Estate Settlement Procedures Act (RESPA) mandates that loan servicers respond to borrowers who have disputes about their accounts, make corrections to their accounts when appropriate, and respond to requests for information regarding the account.72 These written communications are referred to in the statute as “qualified written requests.” Under RESPA, borrowers in default can challenge the amount of the claimed default and require the servicer to provide information or correct an error within certain timelines.

Mortgage Servicing and Loan Modifications: 6.4.6 Determining Whether Your Client Has Defenses to Repayment

In some cases, obtaining loan paperwork or talking to your client may uncover potential consumer defenses to collection, such as Truth in Lending Act violations, usury, fraud, or unfair and deceptive practices.77 Whenever possible, the client should not make an agreement to repay money to a lender when there is a substantial defense to repayment. When appropriate, legal claims can be used as bargaining chips for workouts either before or after legal action is commenced.

Mortgage Servicing and Loan Modifications: 6.4.7 Timing

There are significant advantages to beginning a workout discussion as early as possible after the default. There is the obvious advantage of reaching a workout on a smaller default. Getting involved early also avoids the difficulty of addressing the issue at the last minute, when a potential foreclosure sale date is pending; it makes the borrower appear more responsible in trying to prevent the problem from getting out of hand; and, in some cases, it avoids the extra layer of complexity when a foreclosure lawyer is involved on behalf of the lender.

Mortgage Servicing and Loan Modifications: 6.4.9 Saving Up a Lump Sum

Borrowers should be encouraged to save anything possible toward the mortgage while a workout is being discussed. (If possible, those funds should be placed in escrow.) Even if the mortgage holder has refused partial payments, after several months the accumulated lump sum may be useful in workout discussions. In some instances, a growing arrearage balance may at some point make a loan modification unfeasible.

Mortgage Servicing and Loan Modifications: 6.5.1 Knowing What Terms to Request

Advocates for borrowers with Fannie Mae, Freddie Mac, FHA, VA, RHS, and USDA loans should understand the rules that apply for those loans in helping borrowers assess potential workout options. For loans held in portfolio or in a private-label securitization, the situation is more challenging because there are not fixed modification programs with transparent terms. Many servicers have adopted an internal modification protocol post-HAMP, but it is difficult to know when these protocols apply.

Mortgage Servicing and Loan Modifications: 6.5.2.1 Generally

As discussed above, when evaluating a loan modification or other workout proposal, first determine who holds, guarantees, or insures the mortgage. The servicer should tell you who owns or insures the mortgage. For instructions on obtaining this information from recalcitrant servicers, see § 4.7.2, supra.

Mortgage Servicing and Loan Modifications: 6.5.2.2 Workout Limits Based Upon a Loan’s Securitization

Servicers often claim that when a mortgage has been securitized, the servicer’s actions are limited by a pooling and servicing agreement (PSA), and spelled out in servicing contracts or guidebooks which are incorporated by reference in the servicing contract.81 Some pooling and servicing agreements give servicers the ability to modify any loans, while others cap loan modifications to a fixed number or percentage of the outstanding balance in the loan pool.82 Still other PSAs limit certain modificati