Middletown New York Bankruptcy Lawyer

Home Mortgage Loan Modifications

Proposed legislation to permit bankruptcy judges to modify most home mortgages failed to pass Congress in 2009. Consequently, the options available to persons needing bankruptcy relief to restructure their debt and who also want a loan modification are (i) government programs, (ii) internal mortgage industry programs, and, (iii) where provable against the lender, in connection with the settlement of litigation for exceptional mortgage origination fraud or significant mortgage servicing abuse. (Mortgage-related litigation is not discussed further here.)

Bankruptcy Court Loss Mitigation

Although bankruptcy judges cannot enter orders modifying home mortgages except in a Cram Down/Strip Down situation, they can and do restructure them to permit the borrower(s) to cure and reinstate pre-bankruptcy mortgage defaults over a period of up to 5 years in a Chapter 13 Bankrupcy. In addition, Bankruptcy Judges in the Southern District of New York oversee a bankruptcy court-sponsored loss mitigation program to permit debtors and creditors to attempt to work-out a mortgage default with greater transparency and accountability than is often available through mortgage industry loss mitigation programs outside of bankruptcy. The principal loss mitigation/loan modification programs being handled by mortgage servicers inside and outside of bankruptcy currently are those created by the Obama administration.

HAMP and HARP

In March of 2009, the Obama administration rolled-out two (2) new mortgage loan modification initiatives under the Making Home Affordable program. These initiatives are administered by the U.S. Treasury, through its agents Fannie Mae and Freddie Mac: HAMP and HARP. Both HAMP and HARP offer subsidies to mortgage servicers for modifying or refinancing mortgages.

HAMP stands for the Home Affordable Modification Program. HARP stands for the Home Affordable Refinance Program. Both HAMP and HARP are available to home borrowers outside of bankruptcy, and inside bankruptcy at the mortgage loan servicer's discretion. To be eligible for HARP, borrower(s) must be current on their mortgage loan although at risk of imminent default. For this reason, few borrowers in bankruptcy will be eligible for HARP, and it will not be further discussed here.

A successful HAMP modification results in an interest rate reduction generating monthly mortgage payments of 31% of the borrower(s) monthly gross income. If the loan is an adjustable rate mortgage (“ARM”) or an interest-only loan, it converts into a fixed rate, amortizing mortgage. Interest is capped at the Freddie Mac conventional mortgage interest rate as of the date of the modification, or the rate producing the 31% gross monthly income payment, whichever is greater. Principal reduction is available to reach the 31% gross monthly income payment level, but only at the option of the servicer. (Principal reduction is expected to be a very rare occurrence.) If the holder of the first mortgage loan also holds a second mortgage loan, HAMP provides a mechanism for modification of the second mortgage as well.

To be eligible for the federal subsidies and incentives made available to mortgage loan servicing companies ('servicers') under HAMP, a servicer must enter into a written agreement with the government. That agreement and the guidance to servicers by the Treasury set the parameters for the administration's loan modification program. Servicers that have not signed a written agreement with the government may also use the program's loan modification guidelines.

The HAMP Process

When a borrower applies for a home mortgage loan modification and the servicer has signed up for HAMP, the servicer must collect extensive financial information from and concerning the borrower. The process resembles the processing and underwriting of a new full-documentation mortgage loan. Tax returns and credit reports are obtained, employment and permanent income are verified, an appraisal is conducted, and the servicer then anaylzes whether the loan holder will do better by modifying the loan than by denying the modification and going forward with foreclosure. This is called the net present value ("NPV") test. If the NPV is higher by modifying the loan under the HAMP guidelines than by foreclosing, then the borrower(s) is/are offered a 3 month trial modification. If all payments required under the trial modification are made in full and on time, then a permanent modification is offered to the borrower(s). Failure to make any of the payments required under the 3 month trial modification in full and on time (received and posted within 30 days of the due date) mean s the modification will be rejected. Only one HAMP modification is ever available on any loan.

HAMP establishes a step-by-step process, referred to as the “HAMP Waterfall”, to reduce monthly mortgage payments:

STEP ONE: Determination of Eligibility. The specific eligibility requirements for HAMP applicants are:

• They must own the 1-4 unit property and use it as their primary residence;
• They must establish that they are suffering a financial hardship;
• Their mortgage must have originated on or before Jan. 1, 2009;
• Their unpaid mortgage balance must be less than $729,750.00 for a single family residence (NOTE: this sum escalates to $1,400,000.00 for 4-unit properties);
• Their monthly mortgage payment must exceed 31% of their gross income; and
• Their mortgage has not been previously modified under HAMP.

STEP TWO: Calculate Applicant’s Gross Monthly Income. The goal is to reduce the applicant’s monthly mortgage payment to 31% of their gross monthly income (hereafter referred to as the “31% target”). The monthly income is calculated as the gross amount before payroll deductions, and includes wages, salaries, overtime pay, commissions, fees, tips, housing allowances and other compensation, including Social Security income.

STEP THREE: Capitalize the Arrearages. The lender/servicer will add to the unpaid mortgage balance (technically referred to as “capitalizing”) the past due interest, unpaid property taxes and insurance premiums, escrow advances (ie., if the lender had paid property taxes or insurance premiums for the applicant) and other out-of- pocket servicing expenses, excluding late fees owed to the lender/servicer. With this new mortgage balance, the goal is to reduce the monthly mortgage payment, if possible, to the 31% target.

STEP FOUR: Interest Rate Reduction. With the goal of reducing the monthly mortgage payment for the remaining term of the loan to the 31% target, the interest rate will be reduced incrementally to as low as 2% to achieve this. If the modified interest rate is less than the “market rate” at the time (it frequently will be), after 5 years the modified interest rate will increase at a rate of 1% per year until the “market rate” is reached, where it will remain for the remaining term of the mortgage.

STEP FIVE: Re-amortize the Loan. If the 31% target cannot be reached even by reducing the interest rate to 2%, the term of the loan can be extended (technically referred to as “re-amortizing”) up to 40 years, providing the contract between the servicer and the mortgage holder permits such an extension. If not, the re-amortized loan can have a monthly payment based upon a 40 year amortization, with a balloon payment due on the note’s original maturity date.

STEP SIX: Principal Forbearance. If the 31% target cannot be achieved by the above steps, the lender/servicer can defer, or forbear, a portion of the unpaid mortgage balance, interest-free, which would become due as a balloon payment when the applicant transferred the property, paid off the note, or the note matured.

STEP SEVEN: The Net Present Value (“NPV”) Test. Whether a proposed loan modification is acceptable to the lender/servicer is determined by the NPV Test. This proprietary test used by the lenders/servicers is a mystery to those of us in the outside world, and involves an analysis of the benefit to the lender/servicer of entering into a loan modification versus proceeding with a foreclosure. If the lender/servicer determines (allegedly using a mathematical formula) that modifying the loan will produce a greater value to them, they will modify it. If they determine that foreclosure produces the greater value to them, they will deny the modification and proceed with foreclosure.

The HAMP process is difficult to comprehend and ever-changing, especially given the new directives intermittently issued by the government. For the inquisitive, the guidelines followed by the lenders/servicers may be accessed at www.HMPadmin.com. In drafting the above “step-by-step” explanation of the HAMP process the author relied heavily upon an excellent article written by Henry E. Hildebrand III entitled “HAMP and Your Chapter 13 Practice”, which appeared in the February, 2010 issue of the ABI Journal.

The Bankruptcy Court Loss Mitigation Process

Bankruptcy debtors who wish to pursue loss mitigation¹ in their Chapter 7 or Chapter 13 case may do so by filing a request with the Bankruptcy Court for the Southern District of New York. Unless an objection to the loss mitigation request is filed and granted, the Bankruptcy Court will enter an order directing that loss mitigation go forward and setting deadlines for the accomplishment of certain tasks, including the designation of loss mitigation contact persons, the delivery of an information request to the debtor, and the delivery of the requested information by the debtor to the lender’s contact. The order also sets a period during which loss mitigation is to be completed, subject to later requests for extension, and a hearing date for a status conference on loss mitigation.

It is not unusual for a servicer to need 60 days to review and make an initial determination on a debtor's loss mitigation request. Additional information is often requested of the debtor and should be supplied as soon as possible.

Although loss mitigation is not intended to be used as a defense to a lender motion to lift the automatic stay in bankruptcy (see our discussion of the automatic stay elsewhere on this website), during the time that loss mitigation is proceeding, the Bankruptcy Court will not entertain lender motions to lift the automatic stay to permit the commencement or continuation of a state court mortgage foreclosure action.

The feature that sets loss mitigation in the Bankruptcy Court for the Southern District of New York apart from loss mitigation outside of bankruptcy is the provision in the General Order that established the process requiring all parties to participate in good faith and subjecting those who do not to possible sanctions. That is not to say that mortgage servicers do not generally participate in good faith, but rather that the good faith requirement is an incentive for the adequate and timely response to the debtor(s)' loss mitigation request.

¹Loss mitigation is a general phrase that encompasses workout strategies from loan modification to short sales and deeds in lieu of foreclosure.