Homeowners' Considerations Before Applying for a Mortgage Modification

Obtaining a loan modification is the latest magical solution to foreclosure. One new government program after another has been released to help borrowers modify the terms of their mortgages to make them more affordable, and thousands of private companies have begun to offer assistance in qualifying for a loan mod. Obviously, if everyone who can make a payment was given such a program, the foreclosure crisis would have been solved before it began.

Unfortunately, though, the real world has foiled many of the designs of the mortgage industry central planners and regulators. All of the government programs have failed for a variety of reasons, including voluntary participation, lack of clearly defined rules for compliance by the lenders, and unaccountability. Even for the few mandatory participants, the same problems keep creeping up.

Homeowners should expect to run into at least three major issues when attempting to qualify for a loan modification. These problems should be considered before the borrowers decide whether to apply for a modification or not, as they may not apply to other solutions to foreclosure. Of course, some of them will apply to alternative plans to save the house.

First, homeowners will have to deal with unresponsive mortgage lenders and servicing companies. Loss mitigation departments of these large financial institutions have not dedicated the resources necessary to assist all of the borrowers attempting to apply for various solutions. This means that collection departments may call owners tens times a day, but any call made back to the loss mitigation department will not be answered in a timely fashion, if at all. Faxes containing personal financial information and application documents are routinely lost, as well.

Second, the documents governing the securitization process for the mortgage may restrict the number of loan modifications that can be offered. The pooling and servicing agreements (PSAs) may only allow a certain percentage of loans in a pool to be modified. Even if the borrowers can show financial ability to pay a modification plan, they may have to be turned down by the servicing company, unless the loan is moved out of the securitization pool.

A final consideration homeowners should make before applying for a mortgage modification is if they would require a principal reduction. Many loan mods would not be affordable for the long term without decreasing the amount the borrowers owe in total. However, any reduction of principal may be considered by the IRS as taxable income to the owners. This may result in a large, unaffordable tax bill that will cause the modification to fail is the borrowers can not make the monthly mortgage payment and pay the taxes for the forgiven debt.

While loan mods can be a great way for homeowners to modify their mortgages so they are more in line with the borrowers' current financial situations and market conditions, there are also a number of drawbacks. If the servicer takes too long to respond, the foreclosure will proceed anyway. If the PSA does not allow for any more modifications, qualified borrowers may be turned away. And if there is a large tax bill due to the modification, it may be impossible to pay the mortgage and the taxes.