New Loan Modification Guidelines: The Standard Waterfall

It used to be a prelude to foreclosure when a homeowner fell behind on the mortgage payment. Lenders had no consistent set of guidelines on what to do when a borrower defaults, so they usually tacked the missed payments plus late fees onto the principal of the loan without reducing the monthly payment. This did nothing to help homeowners, who were unable to make monthly payments as it was. But now the President's Making Home Affordable plan offers a clear, consistent set of loan modification guidelines to follow in the case of a homeowner who can't meet monthly mortgage payments.

The goal is to modify the terms of a loan so that monthly payments are no more than 31% of a person's gross monthly income. When an eligible homeowner is determined to be at risk of falling behind on payments or facing foreclosure, lenders have a clear set of guidelines to follow. This set of guidelines is known as the Standard Waterfall. In the Standard Waterfall, here are the steps lenders will follow:

1) They will request the borrower's monthly gross income and get verification of that income through tax documents.

2) They will add up your current monthly payment with all fees and property insurance included. Late fees, however, are not included.

3) They will calculate 31% of the borrower's gross monthly income. That is the target, known as the DTI (debt-to-income ratio).

4) They will reduce the interest rate in 0.125% increments to get as close as possible to the target DTI of 31%. The lender does not have to reduce the interest rate any lower than 2%.

5) If the 31% DTI hasn't yet been reached, the term of the loan can be extended up to 40 years.

6) If the 31% DTI still hasn't been reached, the lender can start to forbear principal - although they do not have to. That amount will be due in a balloon payment upon maturity of the loan.

Lenders will get incentive payments for every modified loan that they perform. If they follow the Standard Waterfall outlined above, run a cost analysis, and determine that with the incentive payments they will have a better financial outcome than if they foreclosed on a home, they will modify your loan. After a successful three-month trial period with the new terms, the new interest rate will remain in place for the next five years.

Lindsy Emery "Loan Modification Guidelines" , Home Loan Modification Guide and Resource