When Loan Modification Will Not Help, or Is Not Appropriate

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In talking about loan modification, I have said it is not a panacea. Let's look at why not, and situations where it just flat out is not going to work.

Loan modification is a strategy for the lender to mitigate their loss, not a "be kind to borrowers" holiday. The lender has to make out better by agreeing to the loan modification than anything else they could do. This means if they can get all of their money by foreclosing, but won't get all of their money via a loan modification, then they will foreclose. The first rule of getting a loan to pay for a property is that the lender always gets every penny of their money first. If they hadn't loaned it to you, you wouldn't have the property in the first place!

The obvious situation where a loan modification is not appropriate is where you have the ability to refinance. If you have the ability to refinance into something more sustainable, I'd suggest doing so without delay. The fact that you don't want to or may be hoping for something better is unimportant. What you're trying to do is keep your property, and not kill your credit-worthiness. If you are able to refinance, get it done.

The second situation is if you have 20% or more equity. In such cases, the lender is going to tell you to sell or refinance the property if you can't make the payments. Never mind that the market is down and it's a rotten time to sell, if the sale of the property will clearly net the lender their money, they are probably not going to agree to a loan modification. Plus, if you do sell, you come away with some cash. If you decide not to sell despite the lender's advice, they will foreclose. They're still going to get their money - which is what you agreed to when you took out the loan - before you get a penny, and you're still not going to have the house. I've written before about what happens to equity under foreclosureThe fact that you don't want to is basically irrelevant. Here's the situation: You owe them their money. You agreed to pay it back in order to get custody of their money and buy the house. They want it: They have shareholders to whom they have a fiduciary duty to get the best return on their money.

The third situation is if you have no income, or a clearly insufficient income to ever pay the loan back. If you're unemployed, there's not an income there to make the payments with. If you were a million dollar per year stockbroker, but now you're a minimum wage employee, you're not going to keep your million dollar property. You are asking them to modify the loan to help both you and the lender. But if the debt to income ratio is not going to work at any reasonable rate of interest, why should they modify your loan if there is no ability to make the modified payments? If all you can afford is 0% interest for the forseeable future, it's only going to get worse from here on out. They might as well bite the bullet and foreclose, because modifying the loan isn't going to do them any good. You''re still going to need to be foreclosed upon.

The fourth situation is new debts - particularly voluntary ones. Some folks see themselves headed off the edge and charge up a storm on all their credit cards, and take out loans for cars, furniture, etcetera. They figure that bankrupt for an additional $100,000 isn't any worse. They're wrong, by the way. If you only have one debt you can't pay, but four credit cards all with zero balances and you go to bankruptcy, you only included 20 percent of your lines of credit in the bankruptcy, and that hurts your credit a lot less than including those four cards and five more tradelines. The person who goes bankrupt with only one bad line of credit while keeping several good ones will probably still have open lines of credit, to boot, and therefore the means of re-establishing payment history. The zero balance credit cards will likely move you to a higher interest rate and more unfavorable terms if you declare bankruptcy, but they will quite likely want you to remain their customer. After all, they got every penny they were due from you!

But if you just took out another $20,000 in debt, that is, in the lender's eyes, evidence of irresponsibility. You already can't make your debt payments, and you go out and get some more? In cases like this, they're not very forgiving of the behavior. Why should they modify their loan when to their eyes you are simply likely to go out and get yourself further into debt?

Loan modification is a possible way out when you cannot refinance, there is no equity, and you have an income and have been behaving responsibly. You just got caught by circumstances beyond your control. If any of these do not apply, you shouldn't expect your lender to agree to bail you out by modifying the loan, when there is clearly no incentive from their point of view in doing so, and they're just going to lose more money if they do.

Caveat Emptor

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About this Entry

This page contains a single entry by Dan Melson published on October 20, 2008 7:00 AM.

How Loan Modification Benefits The Real Estate Markets was the previous entry in this blog.

Why You Should Not Walk Away From Upside-Down Real Estate is the next entry in this blog.

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