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Are Loan Modifications Causing Foreclosures?

08/20/2010 10:59 am ET | Updated May 25, 2011

When the economy crumbled in 2008 as real estate values plummeted, Congress was under pressure to appease the public's demand for action to stem the tide of foreclosures. Congress considered repealing the prohibition in the law against bankruptcy judges modifying the terms of predatory mortgages, but rejected that option, inexplicably taking its marching orders from bank lobbyists, the very industry that caused the economic collapse in the first place. Instead, in February, 2009, Congress passed HAMP, a loan modification program touted as the answer for American homeowners facing foreclosure. While HAMP permits the banks to pay "lip service" to their commitment to helping the American homeowner save their homes, the banks are well aware that most loan modifications requests fail. The banks are also aware that the price of failure is often a foreclosure precipitated at least in part by the HAMP requirement that homeowners must be in default on their mortgage before applying for a loan modification.

One-and-a-half years after HAMP, the foreclosure rate continues to soar. For every one of the past 17 months, foreclosures have remained above 300,000 per month, an unprecedented event in American history. According to RealtyTrac, the foreclosure numbers for the first half of 2010 increased by eight percent compared to 2009, and the 2nd quarter of 2010 set a record for the number of foreclosures in a three-month period. Not only is HAMP helping far fewer homeowners than promised, there's some evidence that HAMP may be leaving more homeowners worse off than if they never had entered the "loan mod" program in the first place.

The government pays mortgage servicers $1,000 for each "loan mod" application. Studies have shown though that mortgage servicers stand to make far more in fees from a foreclosure than they ever will from a loan modification request. (Why Servicers Foreclose When They Should Modify, Nat. Cons. Law Center, 2010). No one has ever accused corporate America of not knowing how to put its own self-interest first. Perhaps this is why my client's complaints sound a consistent theme about loan modifications. They describe a bureaucratic nightmare, fraught with delay, and requests for the same documents again and again. Phone calls go unanswered and messages unreturned. When clients do reach a live person, they complain that the answers they get vary depending on who happens to pick up the phone that day.

When homeowners ask their bank whether they're eligible for a "loan mod," they are incredulous to hear that they need to be at least 60 days behind on their mortgage in order to qualify. This is a rigid requirement. It doesn't matter if a homeowner has managed to stay up to date only by liquidating a 401k or borrowing from parents. The bank won't even consider a HAMP "loan mod" unless the mortgage is in default for 60 days. Many homeowners, already skating on thin ice financially, don't need to be invited twice to begin missing mortgage payments. The banks do nothing to pre-screen homeowners to ensure they are good candidates for a loan modification. Unwitting homeowners, not realizing a loan modification will take from six to 12 months, often get far more than 60 days behind with the bank's encouragement. In fact, one couple recently told me that the bank denied them a loan modification because they were "only" 60 days behind on the mortgage. The problem with requiring these kind of defaults is that it forces homeowners to bet their home on a successful outcome despite the fact most "loan mods" fail.

HAMP requires a trial period of payments before a "loan mod" receives final approval. I have had several clients stuck in "loan mod" limbo making probationary payments for more than six months. During this process, one received a call from a bank collector apparently working from a list of people behind on their mortgage. This person asked if she was interested in one of their "loan mod" programs. My client informed him that she already enrolled in one so she was not interested in applying. She later learned that her answer was misconstrued to mean she was not interested in any program, and her application was canceled. This left her several months behind on her mortgage without a solution, jeopardizing her home.

The overwhelming majority of "loan mods" are either denied outright or fail, leading to a foreclosure. One of my clients faced a foreclosure on July 30th after a "loan mod" denial, even though the HAMP regulations were amended in June 2010 to prohibit foreclosures while a "loan mod" is pending. One of the many problems with HAMP is that it is toothless, not providing any private right of action to homeowners to go to court to complain that their bank failed to follow HAMP regulations. This client had paid an internet company $2500 to do a loan modification for them. He still had to file a chapter 13 bankruptcy to save his home from foreclosure.

The government imposes no penalties for banks that have backlogs of hundreds of thousands of loan modification requests. Banks, overwhelmed by the number of loan mod applicants, find it easier to cut down on the number of applicants by losing paperwork and creating other unnecessary hoops for homeowners to jump through. Many homeowners are so discouraged by this kind of institutional arrogance that they just stop trying. To the banks, this is just a number's game, and they don't much care that there are real people facing real disasters on the other end of any "loan mod" request that slips between the cracks. As one bank told one of my clients, "we don't need to work with you, we've already been bailed out." There's no bailout for the little guy.

That being said, there's no reason a homeowner can't complete a "loan mod" on their own if they are cautious. Here are some tips that might help homeowners trying to negotiate the 'loan mod' labyrinth on their own:

(1) Given that HAMP is helping far fewer homeowners than expected, do a reality check on your monthly budget before applying for a loan modification. If juggling credit card payments is the only way you are able to afford your mortgage every month, hoping to drop your mortgage payment low enough to afford all your credit card payments is probably not going to work. That's like trying to hit the perfect golf shot in a difficult situation. I can say from long experience that this doesn't happen very often, so you might not want to bet your house on the outcome. If you can't pay everything, prioritize your debt based on what's most important to you. If you've already applied for a "loan mod," paying your credit cards from the extra money created by your reduced mortgage payments may lead to a foreclosure if you are denied, unless you have a rich uncle to bail you out.

(2) At the risk of oversimplifying, loan modifications are designed to lower your mortgage payment down to 31% of your gross income. If your mortgage payment is already lower than 31% of your gross, you probably won't qualify.

(3) If you decide to do a "loan mod," don't pay an internet marketing company to do it for you. Your desperation makes you vulnerable to being scammed. Even if you get lucky, there's nothing they will do that you can't do for yourself. If you want help, call your local HUD office for the telephone number of a HUD loan modification counselor near you or call 1-888-995-HOPE (4673). They will help you for free.

(4) You might think providing all of the required documentation in a timely fashion is enough, but that just gets your foot in the door -- you and the other few hundred thousand homeowners waiting for the same answer. Assume your bank is overwhelmed, will lose your paperwork and not return your phone calls as a means of controlling the number of "loan mods" it has to actually consider. Don't take it personally. The clients that succeed have a bulldog persistence and aren't shy about contacting their bank on a regular basis. Keep a copy of everything you provide the bank.

(5) Don't get any more than 60 days behind on your mortgage unless you are ready to give up your home if you aren't approved for a "loan mod." If your bank insists that you have to be more than 60 days behind before being accepted for a loan modification, ask them to put it in writing and file a complaint. Try to bank the money saved by not paying your regular mortgage payment, or the "loan mod" process may leave you in a worse position than you were before applying.

(6) Keeping in mind that most banks have several "loan mod" programs available, you should make sure you've exhausted all the alternatives before accepting "no" for an answer. I had one client denied under HAMP who was able to avert a foreclosure by qualifying for another "loan mod" program, something the bank had never mentioned.