UTAH REAL ESTATE INVESTOR

Adjustable Rate Mortgages (ARMs) have received a lot of bad press in the current economy.  But are they really bad and are they really the cause of the “housing crisis” that we are facing? 

No.  ARMs are not bad loan products.  But they do have a time and place, a specific purpose and use.  The problems that we are seeing right now are a result of the ARM loan products being used incorrectly.  So what would be the appropriate use of an ARM loan?

The ARM loan product was designed to be a short term program to assist those who are otherwise financially challenged (bad credit mostly) to be able to get into a home and begin rebuilding their credit.  A person with bad credit could get a home loan which is the single best credit building credit line available.  Then over the course of those first 2-3 years this person could restore their credit worthiness in order to get into a standard fixed-rate mortgage at market rates.

The problems that we see today are the result of those ARM loan products being marketed to everyone regardless of ability to repay.  Many people were given ARM loans and their ability to repay was based on the introductory rate.  Once the rate adjusted these people were unable to afford their mortgages any more.  The shorter the time frame to an adjustment the shorter the time frame before default.

Should we keep ARM loan products on the market?  Absolutely.  But they should be used for their intended purpose, a time for a person to improve their credit so that they can get a good fixed rate mortgage on their home.  It may be appropriate to require home buyer education and financial literacy before an ARM loan is originated to guarantee that the borrower understands what kind of loan they are getting and to help them make appropriate plans to improve their credit within the time frame of their loan product.

I have talked to many people who do not understand how the “Making Home Affordable” loan modification payments are calculated.  The 2 biggest mistakes I have heard are:

1. The loan modification will be 31% of your gross income or,
2. The loan will be modified to a 2% interest rate.

Unfortunately neither option is correct.  The Home Affordability Modification Program (HAMP) Standard Modificatin Waterfall (loan modification calculation) follows the following steps to calculate a modified payment for a borrower:

1. The borrower’s interest rate on converted to a fixed interest rate on a fully amortizing loan.  If the Adjustable Rate Loan (ARM) is set to adjust within 120 days then the rate will be calculated at the higher interest rate.
2. The accrued interest, escrow advances, and servicing fees are capitalized into the principal balance owed.  Note: Late fees may not be capitalized and must be waived if the borrower qualifies for a permanent modification.
3. The interest rate is reduced in increments of .125% to reach a payment equal to 31% of the borrower’s gross income.  The interest rate cannot go below 2%.
4. If the target mortgage payment has not been reached then the loan may be ammortized up to 40 years (480 months) from the date of the permanent modification.  No negative ammortization is allowed.
5. If the target mortgage payment has not been reached then a principal forbearance (no interest, no payments) must be created so that any principal over 100% LTV is not included in the modification payment.
6. This is no requirement for lenders to forgive any principal under the HAMP modification.  If the target mortgage payment cannot be achieved through the previous 5 steps then the borrower does not meet the income qualifications for the loan modification under the HAMP and will have to pursue other workout options.

Example 1:

Let’s pretend that John Borrower bought a $300,000 home 2 years ago.  He paid $25,000 down payment and got a$275,000 ARM loan at 7% interest and a PITI payment of $1,830/mo (assuming $125 for taxes and insurance).  His loan is going to adjust to 7.25% in 90 days and his payment will increase to $2,005/mo.  John’s employment income has been reduced to $2,355/mo gross income and his property value has fallen to $200,000.  Due to the reduced income John is now behind 3 months.  Here is how John’s modification would work out…

John’s target mortgage rate is 31% of his gross monthly income.  With $2,400/mo gross monthly income his target payment is $744/mo.

1. John’s interest rate is converted to a fixed rate, fully ammortizing loan.  Because his rate will adjust in less than 120 days the higher rate is used for the conversion (7.25%).  John’s loan payment would become $2,005/mo.
2. John’s 3 late payments ($5,490 would be capitalized into his loan) for a new balance of $280,490.  The resulting payment would now be $2,038/mo.
3. The interest rate in now adjusted down in  .125% increments from his converted interest rate until the modified payment reaches the target monthly payment or 2%.  In John’s case the interest rate reaches 2% resulting in a payment of $1,162/mo ($280,490 principal, 2% interst, 30 year fixed rate mortgage, $125 taxes and insurance).
4. Since the target mortgage payment has not been reached the length of the loan is extended to 40 years resulting in a payment of $974/mo ($280,490 principal, 2% interest, 40 year fixed rate mortgage, $125 taxes and insurance).
5. The target payment has not been reached so the lender must give a principal forbearance.  In this case the market value of the property is $200,000.  The lender will have to give a forebearance in an amount up to $80,490 (the final Loan To Value on the interest bearing principal must be 100% or more).  The modified payment now becomes $744/mo ($204,408 interest bearing principal, 2% interest, 40 year fixed rate loan, $125 taxes and insurance).
6. Because we reached the target payment amount John would qualify for the loan modification under this program with a modified payment of $744/mo.  If John made less than $2,360/mo gross income (target payment of $730/mo) then he would not qualify for the loan modification based on income.

Example 2:

Let’s pretend that John Borrower income is actually $4,000/mo gross monthly income.  This creates a new target payment of $1,240 (31% of $4,000).  John’s modified mortgage payment is calculated as above (as follows)…

1. John’s rate is converted to a fixed 7.25%, fully amortized loan.
2. The mortgage is capitalized to $280,490.
3. The interest is reduced in .125% increments to as close to $1,240 without going under.  The resulting interest rate would be 2.625% and the resulting payment would be $1,252/mo ($280,490 princpal, 2.625% interest, 30 year fixed rate, $125 taxes and insurance).
4. At this point John would be qualified for a modified payment under the HAMP program with a payment of $1,252/mo. 

Keep in mind that there are other factors required to qualify for the loan modification.  This information is designed to give a consumer a general idea of how the modification payments are calculated.

Remember, loan modification help is FREE. Beware of scams! For more information on the Making Home Affordable loan modification program check out their website at http://makinghomeaffordable.gov.

For more information on Foreclosure Prevention visit www.hud.gov or www.CommunityActionUC.org. To find a FREE HUD-approved housing counselor to explore your options call 1-800-569-4287 (TDD 1-800-877-8339).

The Making Home Affordable home loan modification is a great program that can help home owner facing a financial hardship to keep their homes and get back on their feet.  This modification program reduces the home mortgage to 31% of the owner’s gross income for a period of 5 years; after 5 years the mortgage will gradually return to a market (fixed) interest rate for the remainder of the loan.

So how do you qualify for this program?  You must meet a few qualifications…

1. Are you facing a significant financial hardship that is making it difficult to pay your mortgage obligation?
2. Is the mortgage on your primary residence?
3. Is your first mortgage less than $729,750?
4. Was your home mortgage created before January 1, 2009?
5. Is your mortgage payment (see below) greater than 31% of your gross monthly income?

If you can answer “YES” to all of these questions than you may qualify for the Making Home Affordable loan modification program.

You mortgage payment includes the principle and interest of your home loan.  It also includes the property taxes, hazard insurance, flood insurance, condominium association fees, and homeowner’s association fees (including any escrow payment shortage amounts subject to repayment plans).  However, the mortgage payment does not include mortgage insurance premium payments or payments to a 2nd mortgage or other junior/subordinate lien holders.

The gross monthly income includes all income before payroll deductions and taxes.  This includes all cash benefits recieved by the borrower.  All non-taxed income is considered net income and must be mulitplied by 1.25 to calculate the effective gross income.  The loan servicer may consider a non-borrower’s income if the information is voluntarily provided, can be verified and that income “has been, and reasonably can continue to be, relied upon to support the mortgage payment.”

So when you consider the total mortgage payment compared to the total gross income for the borrower (and possibly the household), if that number is bigger than 31% (.31) then you meet criteria number 5.

Remember, loan modification help is FREE. Beware of scams! For more information on the Making Home Affordable loan modification program check out their website at http://makinghomeaffordable.gov.

For more information on Foreclosure Prevention visit www.hud.gov or www.CommunityActionUC.org. To find a FREE HUD-approved housing counselor to explore your options call 1-800-569-4287 (TDD 1-800-877-8339).

Starting back on October 8, 2009 the Treasury Department announced some modifications to the Making Home Affordable home loan modification program.  Effective immediately, borrowers who want to be considered for this home loan modification program can complete the new “RMA” form.  The various home loan servicers may have their own set of forms that they prefer but according to the Making Home Affordable Supplemental Directive 09-07 (dated October 8, 2009) the “RMA” form must be accepted by participating servicers.

Remember, loan modification help is FREE.  Beware of scams!  For more information on the Making Home Affordable loan modification program check out their website at http://makinghomeaffordable.gov.

For more information on Foreclosure Prevention visit www.hud.gov or www.CommunityActionUC.org. To find a FREE HUD-approved housing counselor to explore your options call 1-800-569-4287 (TDD 1-800-877-8339).