Mortgage Modification and Refinancing Under the Homeowner Affordability and Stability Plan

Refinance or reduce your mortgage payments under Obama's plan, meant to slow down foreclosures.

The Homeowner Affordability and Stability Plan, signed into law in February 2009, should allow many more people to stay in their houses and avoid foreclosure. If your loan is owned or controlled by Freddie Mac or Fannie Mae, you have a decent shot at refinancing your mortgage into a fixed-rate, low-interest loan if you are current on your current mortgage and aren't too "upside down" on the property. And regardless of who owns your mortgage, if you are at risk of foreclosure and have suffered a change of circumstances beyond your control, you may be able to get your monthly mortgage payments reduced, and suspend any foreclosure proceedings during the process

The Making Home Affordable Program under the Homeowner Affordability and Stability Plan has two components: a $400 billion refinance program and a $75 billion mortgage modification program.

The Refinance Program

The refinance program, officially called the Home Affordable Refinance Program, will potentially transform millions of Fannie Mae and Freddie Mac loans into stable, 15- or 30-year fixed-rate, low-interest mortgages. Payments under the refinanced loans may increase in some cases, if the homeowner can afford them. The tradeoff for higher payments in the short term is that the amounts will be stable in the long term no more worrying over interest rate resets. The refinance program applies only to mortgages owned or backed by Fannie Mae and Freddie Mac about half of the nation's mortgages. Overall, the program is bound to significantly help decrease the mortgage default rate and stabilize home prices.

To qualify for a refinance of a Fannie Mae and Freddie Mac loan under this program, you have to be current on your mortgage and have good credit, and the house to be refinanced must be your principal residence. Even then, you won't get a new loan if you are more than 5% upside down on your house, meaning that you owe more than the house is worth. For example, if your home is worth $200,000, you won't get the loan if you owe $210,000 or more on your mortgage. Unfortunately, homeowners in areas hit heavily by the foreclosure crisis are typically as much as 25% upside down for example, they owe $250,000 or more on a $200,000 house.

The Mortgage Payment Reduction Program

The mortgage payment reduction component of the Homeowner Affordability and Stability Plan provides a workable way for all lenders to make mortgages more affordable in the short term by modifying the terms of the mortgage. It's too soon to tell whether or not the number of homeowners benefiting from this program, officially called the Home Affordable Modification Program, will be in the millions as predicted by the Administration, but the total number is sure to be large.

You qualify for this program if all of the following are true:

• Your loan is equal to or less than $729,751.
• The mortgage is on your principal residence.
• You are at risk of foreclosure, either because you have missed at least two payments or because your payments on your first mortgage exceed 31% of your gross income.
• You've experienced a financial hardship caused by a change of circumstances, such as loss of a job, medical emergency, or interest-rate reset.
• You can show (by way of a tax return and wage stubs) that you have enough steady income to make the payments under a modified loan.

To get the process started, mortgage servicers will perform a "net present value" (NPV) analysis on all loans in their portfolios that are either at least two months delinquent or that are at "imminent risk" of default. (Mortgage servicers are the middlemen between the lender and the borrower, though some lenders service their own mortgages.) Although the guidelines don't define what "imminent risk of default" means, it probably means loans with a debt-to-income ratio greater than 31%. A loan's NPV is what it would cost (in cash flow) to modify the mortgage compared to the cost of taking the property through foreclosure and selling it. Based on prior experience, many NPV analyses are likely to show that it would cost the lender more to foreclose than to modify the loan. If that's true in your case, the mortgagor servicer will be required to notify you, enter into modification discussions, and modify the mortgage under the program's guidelines if you meet the eligibility requirements. If an NPV analysis shows that the lender would not save money by offering you a modification rather than foreclosing, the lender still has the option of offering you a loan modification under the program's guideline.

The modification program's ultimate goal is to adjust the interest rate and possibly the duration of your mortgage so that your debt-to-income ratio will be no higher than 31%. In other words, your payment on your first mortgage, including taxes and insurance, will be no more than 31% of your gross income. Your debt-to-income ratio won't include payments on a second mortgage on your house, installment payments on a car or other secured property, or mortgages on other houses you happen to own.

To get to the 31% debt-to-income goal, a lender will first reduce the interest rate to as low as 2% (for five years), and, if necessary, extend the term of the loan to a maximum of 40 years (from its inception). Using this process, the lender reduces your payments to a debt-to-income of 38%. After that point, the government will share equally in the cost of the rest of the reduction down to 31%.

Servicers can also modify a mortgage loan by reducing its principal or delaying payment on part of the principal until the end of the loan. It's more likely, though, that the servicer will change interest rates and the length of the loan rather than forgive or forbear any principal.

Under the guidelines for the mortgage modification program, foreclosure proceedings must be suspended during the time that you are engaged in the modification process until the end of the three-month trial period during which you are making your new payments on your modified mortgage assuming you are successful in obtaining one.

You can see a summary of the program at www.treasury.gov. The guidelines themselves are found at www.treas.gov/press/releases/reports/modification_program_guidelines.pdf.

Participation in the mortgage modification program by mortgage servicers is voluntary, but most of the big ones have already indicated their willingness to play along. One reason: The program provides monetary incentives to servicers for keeping people in their homes and to lenders for agreeing to modify the mortgage. (The incentives make it less likely that a servicer would make more money off a foreclosure than it would modifying your mortgage to the 31% debt-to-income level.) Note that once a mortgage servicer accepts any federal "bailout" money, its participation in this program is mandatory.

The program also includes incentives for mortgage servicers who are able to extinguish second liens (second mortgages, for example) on the property. Extinguishing second liens will make mortgages more affordable, improve loan performance, and help prevent foreclosures.

Starting the Modification Process

Your mortgage servicer is supposed to contact you if you appear to be eligible for the program, though there is no guarantee this will happen. Before contacting your lender, it's a good idea to talk to a nonprofit housing counselor certified by the Department of Housing and Urban Development (HUD) about your options. To find a free counselor, call 888-995-HOPE or go to www.hud.gov and click on Foreclosure Avoidance Counseling.

Don't Pay for Modification Assistance

Under no circumstances should you pay anyone to help you with your mortgage modification. According to promotional materials that have come my way, a bevy of mortgage brokers are being retrained to negotiate mortgage modifications, charging $1,000 and up for the same services you can get for free from a HUD-certified housing counselor. Because laws in some states prohibit people from taking money up front to help rescue people from foreclosures, some of these modification companies are hiring lawyers who are authorized to accept up-front payments to be their pitch persons. Lawyers can be helpful in certain situationsfor instance, you may want to hire a lawyer to challenge a foreclosure in court or to help you file for bankruptcybut lawyers have no magic keys to the kingdom of mortgage modifications. Again, you and your wallet will be better off with a free HUD-certified counselor.

Weigh Your Options

Before signing off on any new mortgage terms, ask yourself whether you would be better off holding on to your house or walking away. If you can get a lower payment under the new laws, you may be more inclined to keep your house, but it may depend on just how big a reduction you can get and whether your negative equity is so large that it makes more sense to use your state's foreclosure laws as a means to put away some money. In other words, even if you qualify for a monthly reduction in payments of several hundred dollars, you might be better off allowing your house to be foreclosed on by not paying your mortgage altogether, you could save thousands of dollars during what is often a very slow foreclosure process. If you decide that it's in your best interest to walk away from your mortgage, but you want to stay in the house as long as possible payment free, the only effect the new laws are likely to have is to lengthen the time you can stay before you have to leave. That's because mortgage lenders must suspend foreclosure proceedings during the processing period (and because they will be busy negotiating modification terms with other homeowners, making them less efficient in bringing foreclosure actions).

For more information on these and other ways to avoid or delay a foreclosure, see Foreclosure Survival Guide: Keep Your House or Walk Away With Money in Your Pocket, by Stephen R. Elias (Nolo).