What's the Dope on "loan modifications"?

Background: I bought a new house before selling my old house, and therefore didn’t have much of a down payment to make on the new one. So the mortgage payment on the new house is large.

Now that I’ve been fortunate enough to sell my old house in this slow market, I have a large sum of money I can pay on the new mortgage. So I’ve been shopping around for a mortgage refinance. The first Good Faith Estimate I got is over $4,000 for a refinance.

Tonight I called Century 21 Mortgage, the company that holds my mortgage. When I inquired about refinancing the guy got some basic information and then told me he probably shouldn’t be telling me about this, but I should see about a “loan modification.” He said that will cost about $250 as opposed to thousands for a refinance. He offered to transfer me to another department that could handle that for me, and I of course agreed (couldn’t hurt to see what they have to say.) But unfortunately that department closes at 8:00 and I couldn’t talk to them today.

So that gave me a little time to research. A loan modification seems to be for people who are struggling to pay their mortgage, and the lender will modify the terms of the mortgage rather than head towards foreclosure.

Trouble is, in the 8 months I’ve had this mortgage, I’ve never made a late payment, in fact I usually pay more than the minimum. Plus I have a large sum of money to pay on the loan.

So what’s in it for them? There’s nothing about me that would be a risk, other than the large monthly payment I’m now paying. Am I really onto a secret program here or should I be extra-careful about tricks?

You’ll know more when you talk to someone, or when someone who knows what they’re talking about shows up here, but in the mean time…
The statement I quoted makes me think what they would be doing is turning the loan into an ARM/interest only. If this is the case, here’s what they would do…
Look at your mortgage, (BTW this assumes the interest rate would remain the same) and find out how much you pay each month in interest. This would be the new payment. Yeah, it’s great if you can’t afford a full payment, but not only are you not building any equity in the house, you arn’t paying down your principal either. The way it was described to me, they’re [ARMs] desinged for people that only plan to live in their house for a few years and are willing to trade equity for lower payments.
If I were you, I would do one of three things.

  1. refinance
  2. put the money into a savings account and use it to make the payments on the house*
  3. put all the money into the next payment and make a huge principal payment, but if you do this, your next payment will be the same as it always was, but alot more will go towards principal
    *what I would probably do is put all the money that I’ll need for the next sixth months into a savings account. Everything I’ll need for next 6months to a year in a 6 month CD and the rest in a one year CD and make some interest in it.

**This all assumes you don’t have any other outstanding debts with a higher interest rate then the mortgage (ie credit cards), if you did you’d want to pay those down first.
As for what’s in it for them, if what I described is the case, they now get to collect interest on the same amount of principal month after month after month. With your current mortgage, the amount of interest goes down each month.

It might be less sinister than that. Three years ago I found myself in a similar situation, buying one house before I could sell another, so had a larger mortgage than I wanted. Once I sold the extra house and paid off a good chunk of the mortgage principal with the proceeds, the bank agreed to recalculate my loan payments based on the new principal and the time remaining on the loan (almost the whole term, since this happened quickly). The net result was as if I had taken out a smaller loan in the first place. It might have helped that this was an ARM (which I refinanced earlier this year with a fixed rate mortgage, I’m happy to say).

In the mid-1980’s, I worked at Norwest (now Wells Fargo) bank. At that time, the bank had thousands of mortgages & loans to farmers, and the farm markets suddenly went south, leaving many of the farmers unable to make their payments.

The bank was suddenly faced with the very real possibility that these farmers would default on their payments, and the bank might find itself owning thousands of farms scattered across the Midwest (at a time when the farm market was tanking, and farms weren’t selling at all, even when priced far below their appraised value. This was a terrifying prospect to the bank!

A high-level decision was made, and the word went out to bank officers in small towns all across the Midwest: contact your farmers, and ask them if they can make any kind of payments toward these loans – even if only to pay part of the interest due. If so, accept that payment, modify the loan to just run for an additional year, and we’ll all hope that the farm market improves next year. Hundreds of farmers were saved by this, and did in fact manage to catch up on their loans in later years. And the bank did fine, too: they avoided defaults on these loans.

The bank also made out in another way. On their books, they wrote these loans off as defaulted when they failed to meet the original terms. (That caused a temporary drop in the bank stock price, but it was already going to drop because of some stupid hedging in the market.) In later quarters, this turned out to be a good deal for the bank – many of these farm loans that had been ‘written off’ eventually were paid by the farmers, so the bank did very well from the ‘modifications’ they made to these farm loans.

It makes sense for your current mortgage holder to modify your loan, rather than lose you to another lender. After all if you go to another lender, they will not get any more interest payments.
Be sure you understand exactly what product they want to move you into.

From here :

Sounds like about what you’re proposing to do - recalculating the monthly payment (based on a different principal figure).

Depending on what has happened to the rates lately, if you can get them to recalc your monthly payment based on a lower principal value because you’ve thrown more cash into the pot, that may be ideal for you. They may not want to, of course, but if rates are similar (i.e. you have little to lose by refinancing) they might do it to keep you as a customer.

That’s assuming this is a fixed rate, of course. If it’s adjustable, they’ll usually recalculate the payment (whenever it adjusts) taking into account any extra principal you’ve paid. Say your mortgage on day 1 is 200,000; after 12 months you’ve paid down 2,000 so the new principal is 198,000; they calculate the remaining 29 years of the loan using a principal of 198,000 giving payment X; if you’ve prepaid 10,000, they recalculate the 29 years using a principal of 188,000 giving payment Y. That’s how our variable loan worked, years ago.

I had the same experience as Topologist - bought a new house before the old one sold, so it was written write into the mortgage that I could pay a lump sum against the principal and re-amortize the remaining term of the loan once the old house sold. I sent in a check and a letter, they sent me back a letter with the new amortization schedule and a new coupon book with the lower payment.

That’s what a friend of mine at a local bank told me this morning.

When I talk to them tonight I’ll let them know I’m shopping around for a refinance and hopefully they’ll modify my mortgage on the same 30 year fixed terms.

Don’t worry, I would never go for a ARM or interest only, I don’t part with my money carelessly. Especially not for 30 years!

I think I’ll refinance/modify because I can still pay the amount I’m paying now, but I’ll only have to pay the new refinanced payment amount. Takes the pressure off quite a bit.

Banks will have their own internal rules on when they can modify v. requiring a refinancing. Often, a modification can happen only if you are within a certain number of months of the original loan–the appraisal/comprables and your financial info should not be outdated–one of the reasons a modification usually costs less is that these closing costs are not incurred.

So, nothing at all sinister about modifying, but do make sure you understand all of the modified terms.