In our previous discussion of Arizona Loan Modifications, we discovered what a “loan mod” is, who can do one, and the process of doing one. This time, we’ll look at the pros and cons of actually doing one. Most of the clients who call our offices asking about loan modifications end up not seeking to do one. Why is that? If you can get an affordable new mortgage, and you can stay in your home, why wouldn’t you? Let’s take a look.
The Case for Loan Modification
A loan modification will be just right for many Americans, and can indeed save their homes from foreclosure, if “the price is right.” The key consideration for these people is the level of price declines in their area or city. You see, only about 7 states have foreclosure “crises,” and of those 7, only 4 are causing most of the trouble (AZ, NV, CA, FL). If you live in any of the rest of the 96% of the country, the chances that a loan mod will work for you are pretty good. Let me explain.
If you live in Cedar Rapids, Iowa, your home has definitely decreased in value over the last 3-5 years, but the price declines were fairly mild, and in fact, home prices INCREASED 1.8% from 2007 to now. Therefore, if you have negative equity in your home, it is likely to be not quite as severe. For example, let us assume that you bought a home Cedar Rapids for $200,000 in 2005. Chances are good that your home is still worth about $175,000 to $185,000. Result: you’re not upside down by a “prohibitive” amount. The loan modification in this case will make your payments more affordable for 5 years. Because of the relatively shallow negative equity, you will likely not have a problem selling your home in 5 years when the loan begins adjusting upward again.
So, what if you DO live in one of the 7 states where prices have declined up to 54%. Does this mean that you can’t do a loan modification because have too much “negative equity?” Absolutely not, as there are no negative equity restrictions to participation in the program. The question is not whether you CAN, but whether you SHOULD.
The Case Against Loan Modification?
According to the Congressional Oversight Panel that regulates loan modification programs, loan modifications are probably NOT going to help families with tremendous amounts of negative equity, or families who default because of job loss. For obvious reasons, you can’t modify a loan if you lack sufficient income. But, what about negative equity? Why would this cause a problem for loan modification?
Let’s use another example, and this time, we’ll apply greater negative equity. If you live in one of the handful of states with the most severe foreclosures, it is likely that your situation looks something like this:
a.) Bought house for $400,000 (First mortgage balance of $387,000, possible second?)
b.) Homes just like yours are now worth $197,000.
c.) You now have approximately $182,600 in “negative equity”.
You now do a loan modification of your interest rate (as occurs in 97% of cases), and as a result:
1.) Old Payment: $2575 p/month
2.) New Payment: $1750 p/month
2.) This modification is in force for five (5) years.
Sounds fabulous, right? Maybe, but this is where practical reality sets in as people contemplate the future:
“I have a new, affordable mortgage payment.”
“I still owe my lender $387,000, plus some late charges, etc.”
“My house is still only worth about $200,000.”
“My loan is going to readjust in five years.”
The Burning Question:
“Will my home double in value in 5 years, so I can actually sell it if I have to?”
This last is what causes many to decide NOT to do a loan modification. They are reasoning, and quite soundly unfortunately, that there is no way their home is going to almost double in value within 5 years. Not only are prices projected to fall for most of 2010, even if they stopped falling and began to rise again (using an optimistic rate of increase of 10% per year), it will still take almost 10 years before the negative equity is wiped out.
You can see the problem: five years from now, there is a likelihood that you’ll be in exactly the same position you are in now. Your mortgage payments will start to increase again, while the situation at large hasn’t changed much, if at all. To make matters worse, your credit score has likely already taken a hit due to your current troubles. So, just when you’ve got your credit built back up, you’re faced with the negative equity problem again.
Now, please understand, I am NOT advocating that you dismiss a loan modification as a possible solution to your mortgage troubles. You just need to be fully aware of what your true situation is, and what it needs to be in the future for a loan modification to actually solve your mortgage/housing problem. Many families, when they discover the real situation, decide that a loan modification is simply delaying the inevitable, and it is preferable to just “cut the losses now”. Cutting your losses now is becoming a strong mindset for many borrowers. These homeowners reason that it is better to get rid of the ridiculously over-valued home (either through foreclosure, a deed in lieu of foreclosure, or a short sale), take a credit hit, and start life over. It’s like pressing the “reset” button.
These “strategic foreclosures” are absolutely on the rise among many homeowners. Of course there is an ethical and moral consideration to this, but practical economic reality often overtakes the struggling homeowner. Provided that they do not actually go to foreclosure, and instead work with their lender to do a deed in lieu of foreclosure or a short sale, they WILL be better off. Consider: our latest research shows that the average borrower who conducts a short sale or deed in lieu of foreclosure within 5 months of default will suffer a 175 – 225 pt drop in their credit score. These same people are reporting that they are qualified to purchase a home again within 2-3 years.
The practical reality is that, if you move quickly to expedite the transfer of the home to someone else (the lender or another buyer), your credit damage is fairly manageable. Furthermore, this leads to the positive conclusion that homeowners are much better off dumping their over-priced homes and just buying another home later. Not only will they probably save lots of money on a rental each month, but their credit scores will rebound fairly quickly, enabling them to purchase a newer, cheaper home, WELL BEFORE their old home would have appreciated to the level of the old mortgage. This is hard to argue with, as it makes both economic and common sense.
When the Congressional Oversight Panel reviewed the efficacy of the government’s programs to save families from foreclosure, they were extremely concerned. Their skepticism is valid indeed. The foreclosure programs in place now DO NOT address the issue of job loss, or of homeowners who simply decide that staying in the home makes no economic sense. To the extent that these problems continue and increase, well. . .use your imagination. But only for a few minutes; it will lead to anxiety and depression ;>)
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*Disclaimer: Please always remember: I am NOT an attorney, and neither do I play one on TV or the Internet. None of these pontifications should be construed as specific legal advice. If you need specific legal advice regarding your personal situation, give us a call. We can help you ourselves, or provide a list of housing counselors that are free!