My Friend Got a 2% Loan Modification, Why Didn’t I?
The simple answer is that every loan modification is different – starting with the mortgage loan you had to begin with. It is likely that the terms of the original mortgage you received are different than any other mortgage originated around the same time, due to the loan amount, interest rate, payment term, etc. Because every borrower’s financial situation is different at the outset, the modifications they receive can also be different. It is important to keep this in mind when making comparisons.
The primary purpose of the Home Affordable Modification Program, better known as HAMP, is to set homeowners up with a new mortgage payment that makes falling behind, defaulting on the loan, and eventual foreclosure much less likely. This broad aim is accomplished with a focus solely on making the monthly payment amount more affordable rather than any across-the-board reduction in interest rates or other more favorable terms. HAMP guidelines define an affordable monthly payment as 31% or less of the pre-tax (gross) monthly income for a household. This is referred to as the “monthly payment ratio.”
Now you may be saying to yourself “that seems too simple.” How do they get to that payment amount? Don’t they have to reduce the interest rate to make that work?
The answer? Yes and no . . .
The first step in the process is to determine whether the borrower is eligible for a HAMP Tier 1 modification. The criteria include (1) whether the mortgage loan has had a previous HAMP modification, (2) the loan is delinquent or default is reasonably foreseeable, (3) the property is owner occupied, and (4) the borrower’s monthly mortgage payment is above the monthly payment ratio of 31%. The loan also has to have originated prior to January 2009.
Once eligibility is determined, the HAMP program has guidelines that lay the groundwork for how the servicer gets to this reduced payment. It is referred to as the “waterfall.” The standard Tier 1 HAMP modification waterfall is a series of steps in the evaluation process that adjust the terms of the loan, or crunch the numbers, in order to whittle away and reduce the monthly payment ratio to the 31% target. These steps include: (1) capitalization of past-due amounts, (2) interest rate reduction, (3) term extension, and (4) principal forbearance. The loan servicer must follow these steps in order, but once the monthly payment ratio reaches 31%, the process stops and the mortgage servicer is not required to move to the next step.
Now, we can safely say that capitalization alone will not do much to reduce the monthly payment, but in fact will only increase it. Capitalization is the rolling over of accrued interest, servicing costs, escrow advances, and other arrearages, which are the parts of a debt that are overdue after missing one or more required payments. So, once this first step that has been accomplished, the servicer moves to step two of the modification waterfall: interest rate reduction.
According to the guidelines, a servicer must reduce the interest rate in increments of 0.125% until the monthly payment ratio of 31% is met. The lowest the interest rate can be reduced at this step is 2%; however, in some cases the 31% ratio can be met before that threshold is reached.
For example, take a loan with a principal amount of $400,000 (after capitalization), an interest rate of 6% with 25 years left on the term of the loan, and monthly escrow payments of $400, for a household with a collective income of $8,000 per month. The monthly payment amount is roughly $2,977.21, or a monthly payment ratio of 37%. If the interest rate is reduced (at increments of 0.125%) down to 4%, the payment would then be $2,511.35, meeting the HAMP guidelines for a monthly payment ratio of 31%. Thus, the interest rate reduction could stop there because the ideal payment ratio had been met, and the waterfall stops at that point.
In summary, every loan is different, with different terms, and no two modifications are alike. The terms of a loan modification agreement depend on the loan you start with, the total monthly household income, and at what point in the waterfall process the affordable monthly payment ratio has been met under the HAMP Guidelines.