Mortgage Loan Modifications - Removing the Obstacles

In a previous article I pointed out that the root cause of the current crisis in the financial markets is he ongoing decline in home values. Secretary of the Treasury Paulson said the same thing on Friday Sept 19: "The root cause of distress in capital markets is the real estate correction and what's going on in terms of the price declines in real estate."

Home values will continue to fall as long as supply exceeds demand. In California, based on the Notices of Default already recorded, lenders will probably take back more homes in October at foreclosure auctions (30,000+) than the total of home sales in the state, and that is likely to persist at least until March of next year. Obviously, that will be disastrous for home values.

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Loan modifications could prevent many of those foreclosures and prevent all those homes from being added to the inventory overhang.

A loan modification is a unilateral change of the terms of the Note by the lender. In the many cases where the homeowner cannot make the current payment, but COULD qualify for a lower payment, loan modifications are BY FAR the best workout solution because they keep families in their homes, they cost the lender a LOT less than short sale or foreclosure, they keep those homes off the market, and they don't cost the taxpayers a dime.

Each successful loan modification puts us one house closure to the end of this crisis.

As of this writing in mid September 2008, loan servicers acting on behalf of the investors have become much more accommodating with regard to loan modification requests, but the process is still too slow and too cumbersome.

Three important steps need to be taken in order to clear the way for rapid modification of those mortgages that can still be saved, and now that Congress has authorized the Treasury to buy bad mortgage loans from the lenders, Congress should ensure that these steps are taken immediately:

First, there needs to be a national legal shield that allows servicers to modify loans without concerns about liability to their investors as long as they are fulfilling their fiduciary responsibility to the investor to maximize the value of the asset. This needs to be combined with INCENTIVES for the servicers to take that action quickly.

That is already in place with regard to certain subprime loans due to loan modification guidelines published last year by the American Securitization Forum. Those guidelines need to be universal, and widely promulgated.

Secondly, the "moral hazard" argument needs to be completely debunked. It's time for solutions, not blame. There is plenty of blame for everyone. The "moral hazard" argument says that if homeowners are given a break it will encourage inappropriate risk taking by other homeowners in the future. This easily dealt with through realistic underwriting guidelines which are certain to be imposed by the market as long as investors are clear that the government will NOT bail them out. Fortunately, that is already occurring.

Finally, there needs to be a clarification of FASB accounting standards to eliminate any perceived or real penalty on the value of a loan just because it has been modified. As long as those loans are current, they should be treated for accounting purposes just like any other performing loan with the same loan parameters.

The Treasury Department and the FDIC are already on board on the merits of wide spread loan modification and they are pushing lenders to do more, but they need strong vocal support from both sides of the aisle. It's time for all politicians to be AMERICANS rather than Democrats or Republicans.

And yes, I know it's the political season... TOUGH.

If these three recommendations are implemented with loud support from national political leadership, there is no reason that the mortgage servicers could not quickly (12-18 months) evaluate every delinquent loan and modify those where a loan modification is appropriate.

This is a case-by-case task, but there is no shortage of experienced mortgage professionals who could be enlisted to help process and underwrite these files to ensure that the homeowners can qualify for the modified payments, and there is existing software that can perform the Net Present Value analysis using each servicers own internal assumptions to ensure that the investors are getting the greatest Net Present Value for their asset.

If the political leaders would get on board with this and make it a TOP PRIORITY with ACTION rather than words, they will be leading the way toward the end of the foreclosure crisis and the stabilization of home values.

The losses have already occurred, they just haven't been "realized" in an accounting sense. Loan modifications will allow that process to take place with the least cost to the investors and are the fastest solution to eliminating the inventory overhang that is dragging home values down in this "Toilet Bowl Syndrome".

©Doug C Jones Sept 21 2008. Permission he hereby granted to reprint this article provided the full resource box is included with active links.

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