Applying for a mortgage loan modification is in many ways similar to applying for a mortgage in general. Factors for the lender to consider in a loan modification will include income, and the likelihood that it will continue, as well as how much equity is in the property.
Getting a loan modification on a primary residence, meaning the property where the borrower lives as their main home, is typically much easier than getting one on an investment property.
Lenders in general are more conservative with investment properties than with homes that borrowers live in. This is because if a landlord is dependent on renters for the income to cover the mortgage payments, and renters may pack up and leave at the end of their lease, sometimes even before. They have no attachment to the property.
Homeowners, on the other hand, usually have an emotional attachment to their property, and typically do what they can to hang on to it. In addition, knowing that a foreclosure could disqualify them from buying another home for the next four to five years gives them another motivation to want to keep their home, or at a minimum get out from under the mortgage without going through a foreclosure.
Financial Hardship or Distress
Borrowers, for any of a number of reasons, may find themselves in financial hardship, causing them to be unable to pay their mortgage each month. Loss of income or unexpected expenses are they most typical reasons, and may legitimately result from job loss, business difficulties, a divorce or a medical situation, among causes.
Lenders understand that these circumstances happens, but they want to know how a borrower is going to move forward from the hardship and into a position to be able to make payments once the mortgage is modified.
Writing a hardship letter to the lender at the beginning of the process, and including it in the modification application package will both help save time for overworked lender employees, and clarify where the borrower has been, and where they are headed.
Unable to Refinance Mortgage
As explained in a Chapter 5, refinancing into a lower interest rate or better terms is usually the preferred option for borrowers who are looking to lower their mortgage costs. A loan modification is typically the choice for those who cannot refinance, or whose mortgage already offers attractive terms but need some temporary “breathing room” to get through a financial hardship.
Because a refinance requires good credit though, borrowers who anticipate potential financial stresses down the road should begin to explore a refinance immediately, rather than wait for trouble to arrive. A borrower who has begun to miss or be late on mortgage payments will likely face challenges in trying to refinance, due to a damaged credit rating, and may find that a loan modification their only option at that point.
In considering whether to grant a loan modification, one of the main factors a lender takes into consideration is the borrower’s debt-to-income ratio. This is the ratio of gross monthly income (before taxes) to total mortgage payment. Lenders vary in the maximum debt ratios they will accept, but are typically in the 36 percent to 45 percent range. Compensating factors such as credit score, and the amount of equity in the property will be part of a decision that the lender makes in determining if a borrower should get a loan modification.
An simple example will help illustrate how the debt ratio works.
- Let’s assume there is a borrower that is looking for a loan modification, and has a gross monthly income of $4,000 per month.
- His or her current mortgage payment is $1,400 per month. Taxes are $300 per month, and the homeowners’ association payment, which includes insurance, is $100 per month. The total monthly housing expense is $1,800.
- The debt ratio is 45 percent ($1,800 / $4,000)
If the lender has a maximum debt ratio of 40 percent, but wants to work with the borrower to keep them in their home, they have three options to make the payment affordable for the borrower. They can either:
- Lower the interest rate
- Extend the terms of the loan
- Defer some of the principal each month
- Defer or write off some of the principal of the loan balance. This is the least likely of any of the options to have happen.