Get right side up by modifying home loan

Published 8:24 pm Friday, November 14, 2008

Question: I read your column last Sunday where you said home values will probably fall another 5 percent to 10 percent next year. That’s bad news to us since our home value is already less than our total mortgage balance. We bought our home two years ago with a zero-down loan. We got a large first mortgage for 80 percent of the purchase price and a smaller second mortgage at a higher interest rate for the rest. If home values continue to fall, as you have predicted, how will we ever be able to refinance? There must be many other people in the same situation.

C.H. Everett

Answer: Unfortunately, a lot of people find themselves upside down in their homes, which means that they owe more than their home is worth in today’s market.

As I said last week, home values around the Puget Sound region have fallen by about 10 percent to 20 percent from their peak 2007 values, depending on the individual neighborhood and other factors. Some areas have fared better than others, but virtually all neighborhoods have experienced some degree of depreciation in home prices.

The zero-down loans that were very popular early in this decade are now gone — except for the government-insured Veterans Administration and USDA Rural Housing Development home loan programs.

Lenders are now much more cautious and they are restricting the loan-to-value ratios on conventional loans, especially for cash-out refinance mortgages that are used to consolidate debts.

If you have good credit, you can still buy a home with as little as 3 percent to 5 percent down and you can refinance your existing mortgage balance up to 95 percent of your home’s value. But if you want to pull out some cash and get a mortgage amount large enough to pay off your credit cards as well as your existing mortgage, many lenders now limit you to a maximum ration of only 85 percent of your home’s value.

Since your total mortgage balance is more than your home’s value you can’t refinance, but you may be able to get a loan modification. That’s an agreement by your lender to change the terms of your existing loan.

To qualify, you must demonstrate a financial hardship that makes it difficult or impossible to make your existing loan payments. In many cases, the lender also requires that you must be two or three months behind on your mortgage payments.

If you meet the lender’s requirements for a modification, they will offer to change your loan terms by doing any or all of the following:

Reducing your interest rate.

Extending the term of the loan from 30 to 40 years (which reduces your monthly payment amount).

Deferring principal.

Reducing the principal balance of your loan (but only in rare cases).

In order to get a loan modification, you must be able to qualify for the new, lower mortgage payment. Some people have the mistaken idea that they can get a loan modification if they have lost their job and have little or no income. That’s not true. If you are behind in your mortgage payments and you don’t earn enough money to make the payments no matter how low they cut your interest rate, the bank will simply foreclose and sell your home at auction to recover as much of their loss as possible.

The idea of the loan modification program is to keep people in their homes if they are financially stable and can afford to make their mortgage payments if the bank is willing to give them a break. In most cases, you must earn enough money that the modified mortgage payment (including property taxes and homeowners insurance) equals no more than about 40 percent to 45 percent of your monthly gross income. For example, if a loan modification would reduce your mortgage payment from $4,000 to $2,000 per month you would need to earn at least $5,000 per month in order to qualify for that modified $2,000 per month payment using a 40 percent debt-to-income ratio.

So you can see that a loan modification is a help, but it is not really a free lunch. Many loan modification companies have sprung up all over the country offering to work with your lender and get you a lower mortgage payment. These companies charge fees ranging from $2,000 to $6,000 and in some cases that fee is nonrefundable if they are not successful.

The good news is that you can get a loan modification for free if you are willing to put in the time and effort yourself. The state of Washington has a loan modification help line you can call at 877-894-4663 and you can visit their Web site at www.homeownership.wa.gov. The federal department of Housing and Urban Development also has a loan modification help line at 888-995-4673 and you can visit their Web site at www.hopenow.com.

Mail your real estate questions to Steve Tytler, The Herald, P.O. Box, Everett, WA 98206, or e-mail him at economy@heraldnet.com.