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.

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).

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).

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 essense of the program works like this…the lender will modify the home’s first (1st)  mortgage to 31% of the household’s gross income.  This reduction remains in effect for 5 years.  After the 5th year the interest rate will rise 1% per year until it reaches the original mortgage interest rate where it remains fixed for the life of the loan.

In order to accomplish this modified mortgage payment the lender has 3 options:

1. Reduce the interest rate down to (as low as) 2%
2. Ammortize the loan out to (a maximum of) 40 years
3. Forgive a portion of the loan principle.

To determine if your income would justify a MHA modification you need to determine if 31% of your gross income is equal to (or greater) than the lowest minimum payment allowed by the lender under this program.  The lowest minimum payment is figured by taking your loan balance plus all accrued late fee, charges and missed payments and ammortizing that amount over 40 years at 2% interest.  Then add in your property taxes, hazard insurance and mortgage insurance (if applicable).  This represents the lowest minimum payment under the MHA program.

Example:  John Homeowner has a $100,000 mortgage with payments of $845/month ($125/mo for taxes and insurance).  John has missed 5 payments and the lender has begun foreclosure proceedings (late fees of $400 and attorney’s fees of $3,000).  So John now owes the lender:

• $100,000 principle balance
• $4,225 in missed payments
• $400 in late fees
• $3,000 for attorney’s fees
• $107,625 Now owed to the lender

John’s lowest possible payment under the MHA program ammortizes $107,625 over 40 years at 2% which equals $325.92/mo PLUS $125 ) for taxes and insurance) which equals $450.92/mo.

Most people understand this lowest payment calculation but fail to understand the gross income calculation.  In order to qualify for the modification John’s income must support $450.92 at 31% of his income.  So John must have a gross income of $1,454.58/month and be able to show that he can support the balance of his monthly obligations at that income after the mortgage modification.  Keep in mind that the more money John makes the higher the modification amount will be to keep it at 31% of his gross monthly income.

Should you find yourself facing a potential mortgage default or foreclosure be sure to contact your lender or a HUD-approved housing counselor.  Both are very interested in keeping you in your home and helping you find a solution to your current economic struggles.  And both will usually provide these services for FREE.

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).

Beware of scams!  Solutions that sound too simple or too good to be true usually are.  If you’re selling your home without professional guidance, beware of buyers who try to rush you through the process.  Unfortunately, there are people who may try to take advantage of your financial difficutly.  Be especially alert to the following:

Equity skimming  In this type of scam, a “buyer” approaches you , offering to get you out of financial trouble by promising to pay off your mortgage or give you a sum of money when the property is sold.  The “buyer” may suggest that you move out quickly and deed the property to him or her.  The “buyer” then collects rent for a time, does not make any mortgage payments, and allows the lender to foreclose.  Remember, signing over your deed to someone else does not relieve you of your obligation to pay on your loan.

Hint: Do not sign over your deed or sell your property with a “proper” closing.  And always have payments made to a third party escrow company to insure that the payments are made as agreed.

Phony Counseling Agencies  Some groups calling themselves “counseling agencies” may approach you and offer to perform certain services for a fee.  These could well be services you could do for yourself for free, such as negotiating a new payment plan with your lender, or pursuing a pre-foreclosure sale.  If you have any doubt about paying for such services, call a HUD-approved housing counseling agency at 1-800-569-4287 or TDD 1-800-877-8339.  Do this before you pay anyone or sign anything.

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).

Your lender will determine if you qualify for any of the alternatives.  A housing counseling agency can also help you determine which, if any, of these options may meet your needs and also assist you in interacting with your lender.  Most services are provided FREE of charge.

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).

If you are facing the possibility of foreclosure you may be considered for the following:

• Special Forbearance  Your lender may be able to arrange a repayment plan based on your financial situation and may even provide for a temporary reduction or suspension of your payments.  You may qualify for this if you have recently experienced a reduction in income or an increase in living expenses.  You must furnish information to your lender to show that you would be able to meet the requirements of the new payment plan.
• Mortgage Modification  You may be able to refinance the debt and/or extend the term of your mortgage loan.  This may help you catch up by reducing the monthly payments to a more affordable level.  You may qualify if you have recovered from a financial problem and can afford the new payment amount.
• Partial Claim (FHA Loans)  Your lender may be able to work with you to obtain a one-time payment from the FHA-insurance fund to bring your mortgage current.  If you are between 4-12 months delinquent but can afford the regular monthly mortgage payment you may get a loan (a lien on your property with 0 payments, 0% interest) to bring your mortgage current.  This lien must be paid off when you refinance or sell your home.
• Pre-Foreclosure Sale (Short sale)  This will allow you to avoid foreclosure by selling your property for an amount less than is necessary to pay off your mortgage loan.
• Deed-in-Lieu-of Foreclosure  As a last resort, you may be able to voluntarily “give back” your property to the lender.  This won’t save your house, but it is not as damaging to your credit rating as a foreclosure.  In order to qualify for this option you must be delinquent on your mortgage, not qualify or be successful with any other work out option and only have one (1) mortgage on your home.

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).

1. Do Not Ignore The Letters From Your Lender!  If you are having problems making your payments, call or write to your lender’s “Loss Mitigation Department” without delay.  Explain your situation.  Be prepared to provide them with financial information, such as your monthly income and expenses.  Without this information, they may not be able to help.
2. Stay in your home for now.  You may not qualify for assistance if you abandon your property.
3. Contact a HUD-approved housing counseling agency.  Call 1-800-569-4287 or TDD 1-800-877-8339 for the housing counseling agency nearest you.  These agencies are valuable resources.  They frequently have information on services and programs offered by Government agencies as well as private and community organizations that could help you.  The housing counseling agency may also offer credit counseling.  These services are usually free of charge.

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).

Foreclosure may occur.  This is the legal means that your lender can use to reposses (take over) your home.  When this happens, you must move out of your house.  If your property is worth less than the total amount you owe on your mortgage loan, a deficiency judgment could be pursued.  If that happens, you not only lose your home, you also would owe your lender an additional amount.

Both foreclosures and deficiency judgments could seriously affect your ability to qualify for credit in the future.  So you should avoid foreclosure if possible.

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).