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Can I avoid Bankruptcy with a Loan Modification?

This blog is a follow up to my previous article titled, “Loan Modifications, Foreclosure and Bankruptcy.” In this article, I would like to focus on the fact that the HAMP program goes beyond merely offering false hope, but in fact leads to what could have been a preventable chapter 13 bankruptcy filing. Allow me to explain.

The process of getting a loan modification almost always takes months and months. First, comes the grueling process of getting the bank to actually consider you for a temporary loan modification. Then, theoretically after three months of on-time payments, the bank is supposed to decide on whether or not you have been approved for a permanent loan modification. I say theoretically because a loan modification approval/denial can take as long as one year to receive. And after ten months of phone calls, letters, pleas, a tremendous amount of stress, and not to mention timely reduced mortgage payments, the bank will most likely tell you that you do not qualify for a permanent loan modification. In addition, the bank will tell you that you now have 30 days to catch up on your arrears. So, if you cannot come up with thousands of dollars to make up the arrears, the foreclosure proceedings will immediately begin.

Take for example “Jane.”Jane is a self-employed, single mother who up until recently had very good credit.Jane’s business begins to suffer as the economy takes a turn for the worse.Money is now tight.Despite her financial set-back, Jane is able to keep up with her mortgage payments as long as she cuts back in other areas.However, Jane begins to hear more and more about loan modifications. One day, she runs into a “nice gentleman” who promises her that he will be able to get her the magical permanent loan modification for a fee of only $2,000. Jane signs up with the nice man.Ten months later, Jane is sitting in my Alexandria, VA bankruptcy office talking to a bankruptcy attorney for the first time in her life. And here finally comes my point— The travesty is that Jane, while she suffered a financial set-back, still could have managed to cut back on her expenses and continue paying her original mortgage payments had she not been lured in by the banks with their proverbial “pot of gold” known as loan modification.

What could Jane have done in order to avoid having to file a chapter 13 bankruptcy case? For starters, she should have never paid any money up front to that “nice gentleman” who promised her a loan modification. Jane should have gone to see a Housing and Urban Development (HUD) certified counselor who would have helped her free of charge. Second, she should have consulted with a lawyer, perhaps an Alexandria, VA bankruptcy attorney, who would have offered her some honest advice.Such an attorney could have warned Jane of the dangers of what she was about to do.Such an attorney could have explained to her that she was now taking a gamble and that she needed to cover her losses; the eventual likely scenario of her permanent modification being denied.Jane would have been told that she should save the money she was not spending due to the reduced mortgage payments. This way, if the permanent loan modification was not granted, she would have the money to immediately catch up on the arrears and not face a looming foreclosure and eventual chapter 13 bankruptcy filing.

Well, at this point you might be saying, hey genius, most of us simply do not have the means to put aside every month the difference between the reduced mortgage payment and the original mortgage payment. If we had that kind of money we would not have bothered with a loan modification in the first place. You are absolutely correct.Though, and here comes my next point, had you been warned from the outset that you would likely face ten months of reduced monthly mortgage payments only to face the denial of your loan modification application and subsequent foreclosure on your house, then you would not have “donated” all that money to the bank.Rather, you could have cut your losses, rented a much cheaper apartment, and moved on with your life.

It is almost like the bank intentionally lured you down the path of reduced monthly payments knowing full well that in the end they would deny your application. After all, mathematically speaking, what results in more money for the banks? Ten months of reduced mortgage payments followed by a foreclosure or putting an end to their cash flow by immediately moving in for foreclosure? And besides, they have the Treasury Department and the White House to impress.And that is why many pundits refer to the loan modification program as “extend and pretend.”As in, banks extend temporary loan modifications for a while, take some photo ops, all the while pretending that they will grant you a permanent loan modification.


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Can I avoid foreclosure with a Loan Modification?

When it comes to loan modifications and the Home Affordable Modification Program (HAMP), the old mantra of, “Hope for the best, but prepare for the worse” could not be more true. Unfortunately, for most homeowners who are counting on a HAMP loan modification in order to prevent a foreclosure on their home, the ordeal they face is just a stepping stone to bankruptcy.  But before I get ahead of myself with my explanation of why so many people who are in the loan modification process end up visiting a bankruptcy attorney and wind up in bankruptcy court, I would like to address the fundamentals of the HAMP loan modification process and why it has garnered so much deserved criticism.

How do loan modifications under HAMP work?

HAMP is “supposed to” (and if there was ever a time to state strong emphasis on “supposed to” this would be it) reduce a borrower’s mortgage payment to no more than 31% of the homeowner’s monthly gross income.  That is, if the homeowner is able to demonstrate that their current mortgage payment is no longer affordable due to a financial hardship.  You are supposed to be given a temporary 3 month loan modification, after which time, a decision is supposed to be made to determine if you qualify for a permanent loan modification. The whole purpose of the program is to reduce your monthly mortgage payments after you have suffered a financial set back and allow you to avoid facing a foreclosure of your home.

So what’s the problem with the HAMP loan modification program?

 

It is an extremely long and grueling process that rarely results in the banks agreeing to a loan modification.

While at Church on Sunday with my wife (we were celebrating our 1 year anniversary that day by the way), I read something interesting that struck a cord with me.  Mind you, this is not a religious message, but a short story about struggle and persistence.  The homily spoke about Jesus telling a parable on the necessity of never losing heart. In the story of a widow who suffered injustice from her opponent, the judge was hardhearted, unconcerned with her rights or God’s justice. The woman persisted in her demands, yet he refused to listen. Eventually, though, the judge was worn down by the woman’s pleas and settled the case in her favor.

As has been documented time and time again since the HAMP program was launched last year, if you intend to secure a loan modification, then you had better be extremely persistent and be prepared to wear down the mighty banks.  Like the Judge in the foregoing story, the banks will be hardhearted and unconcerned.  Expect to make dozens and dozens of calls, faxes, letters, and so forth to the banks, all while being given different responses perhaps in the same day.

Who enforces the HAMP loan modification program? Who enforces the HAMP guidelines and ensures that people who qualify for a loan modification do in fact get one from the bank?

 

No one. The HAMP program is voluntary.  The HAMP program is not law.

Contrary to what some may think, you are not entitled a loan modification.

The banks are not legally obligated to give you a loan modification even if you are able to demonstrate, as so many people have, that you qualify for a loan modification.  And despite the hundreds of articles that have been written on the subject, I have been amazed at how little emphasis there has been to highlight this fact. That is until I read the Washington Post article this past weekend titled “With a change in approach, housing crisis can be eased” by Ezra Klein. And so, while the Treasury Department might give the banks a talking to from time to time, to date, despite such legal arguments as “third party beneficiary,” there has been no judge in the country that has ruled that banks must, and not merely ought to, approve a loan modification when the circumstances and numbers are there.

Are permanent loan modifications really permanent?

No. The term “permanent loan modification” is actually somewhat deceitful.

The reason I say that is because there is nothing permanent about the HAMP loan modification program.  There is a reason that you will see some articles putting the word permanent in quotation marks. If you are in the minority, those fortunate enough to emerge from this hellish process with that sought after “permanent” loan modification, then you need to understand that while cracking open that bottle of champagne might be in order, this is not in fact a permanent solution.

The terms of your “permanent” loan modification will only last for five years. What happens after five years? Well, that very low interest rate that you currently have, which has allowed for your much smaller mortgage payments, will be increased by 1% every year until it reaches a certain Freddie Mac cap rate.  So, eventually (granted, years down the road) your mortgage payments will once again reflect roughly what you were paying before you were approved for a loan modification.

What happens to the money that is reduced by the banks if a loan modification is granted?

The banks are not giving you principal reduction.  The difference between the original mortgage payment that you were paying and the monthly payments that took effect during the temporary and so called “permanent” loan modification period are not forgiven. The amount of savings is actually set aside in an account that the homeowner must pay upon sale, refinance or the maturity of the loan.  So, those tens of thousands of dollars that you are able to save during the 5 year “permanent” modification period will have to be paid back to the banks eventually. As with student loans, this is basically a deferment.  And as with any deferment, it will help you in the short run but it hurts you in the long run!