Tuesday, June 5, 2012
TO MODIFY OR NOT TO MODIFY
I have a lot of clients asking me whether or not they should attempt a loan modification. I tell everyone of them the same thing, “That is a decision only you can make, but I can give you some factors that you should definitely consider in making that decision.” I try to help my clients look at their situation through eyes that are not clouded by emotions.
First, it is important to understand how a Lender is able to modify a mortgage. Lenders use many techniques to reduce a homeowner’s monthly mortgage payment. Most Lenders use a combination of stretching out the loan term and reducing the interest rate. Stretching out the loan term simply means a longer payback period and since most loans have a 30-year repayment time, the extended repayment time may be 50 years. For example, if I borrow $100 from you on July 1st and our agreement gives me until August 1st to repay the loan, then I have 31 days to pay you back. That means I have to pay you approximately $3.23 per day to pay off the loan in time. Now, if we change the repayment plan from August 1st to September 1st, I will have 62 days to pay back the loan. Under this scenario my daily payment is reduced to $1.61 per day. The same concept applies to loan modifications. Another way to reduce the monthly payment is to lower the interest rate thereby further reducing the monthly payment. Please keep in mind that it is extremely rare for a Lender to agree to a principal reduction.
This sounds great in theory, but in practice there is another huge factor that needs to be considered: the value of your home. The simple fact is that most of us owe more on our homes than they are worth. This is called being “underwater” on the property. As previously mentioned, most Lenders will not do a principal reduction. That means that if you owe $200,000 on your mortgage and your home is only worth, $100,000, then after you modify the loan (if you get a loan modification) you will still owe $200, 000 on a home that is worth half only half of that. Now, also take into consideration that if your loan is modified via the technique mentioned above, your interest rate will be reduced but you will be paying for many more months than you were previously. Also keep in mind, that unless you haven’t refinanced since the late 1990’s, your modified interest rate most likely won’t be much less than your pre-modification rate. By the time you factor in all the extra payments due to the extended repayment term, you will end up paying much more than $200,000 over the life of the loan. Plus, there is still an issue in that the home is no longer worth the $200,000 that it originally was. You are paying more for a home that has decreased in value.
I mentioned looking at the situation without being manipulated and I know this is easier said than done. I encourage my clients to view their home as they would any other investment. How long would hold on to shares of stock that suffered a high percentage loss in value? Imagine your car was worth $500 and that it needed $5000 worth of repairs. You don’t have the money to get it fixed or to buy a new car so you will have to take out a loan. Would take out a $5000 loan to fix a car worth $500? I would argue that a better use of the $5000 is a down payment on a more reliable car. Taking away the sentimental attachment, is your house any different from the car? They both are worth less than what it would cost to keep them. Neither is guaranteed to increase in value. Both will end up costing you more in the long run.
I understand that there is a strong emotional attachment to a home. My point is that by taking a step back and looking at the big picture, a homeowner can make a better decision regarding their housing situation. A decision that they most likely won’t regret in the future.
Please visit http://simonsandsimonslaw.com/ for more information.