Loan Modification: What you need to know!

At the heart of the President Barack Obama’s ambitious plan to rescue the housing market is the conviction that restructuring distressed mortgages will keep struggling borrowers in their homes and help insert a floor beneath plummeting property values. With $75 billion dedicated to reworking troubled loans, that’s a big bet—especially considering that a top banking regulator said last December that almost 53 percent of loans modified in the first quarter of 2008 went bad again within six months. But supporters argue that mortgage modifications need to be properly engineered to work—and many early ones weren’t. To that end, the Obama administration on Wednesday unveiled fresh details on its plan to restructure at-risk loans and help as many as four million home owners avoid foreclosure. Here are seven things you need to know about Obama’s loan modification program.

1. Payments, not prices: The plan centers on the belief that struggling borrowers will stay in their homes—even as values decline sharply—as long as they can make their monthly payments
. Although not everyone agrees with this, billionaire investor Warren Buffett endorsed the philosophy in his most recent letter to shareholders. “Commentary about the current housing crisis often ignores the crucial fact that most foreclosures do not occur because a house is worth less than its mortgage (so-called “upside-down” loans),” Buffett wrote. “Rather, foreclosures take place because borrowers can’t pay the monthly payment that they agreed to pay.”

2. Thirty-one percent: To that end, the administration’s plan requires participating loan servicers to reduce monthly payments to no more than 38 percent of the borrower’s gross monthly income. The government would then chip in to bring payments down further, to no more than 31 percent of the borrower’s monthly income. In lowering the payment, the servicer would first reduce the interest rate to as low as 2 percent. If that’s not enough to hit the 31 percent threshold, they would then extend the terms of the loan to up to 40 years. If that’s still not enough, the servicer would forebear loan principal at no interest. The plan does not, however, require servicers to reduce mortgage principal, which Richard Green, the director of the Lusk Center for Real Estate at USC, considers a shortcoming. “For underwater loans, if you don’t write down the balance to be less than the value of the house, people still have an incentive to default,” Green says. “Writing down the principal first instead of last—which is what [the Obama administration is] proposing—makes sense to me.”

3. Cash incentives: To encourage participation, servicers will be paid $1,000 for each modification and will get an additional $1,000 payout each year for as many as three years, as long as the borrower continues making payments. Borrowers, meanwhile, can get up to $1,000 knocked off the principal of their loan each year for as many as five years if they make their payments on time. Neither party can receive the cash incentives until the modified loan payments have been made for at least three months.

4. Financial hardship: The Obama administration is pitching its plan as an effort to help responsible homeowners ensnared in the historic housing slump and painful recession—not speculators. As such, only owner-occupied, primary residences with outstanding principal balances of up to $729,750 are eligible. Occupancy status will be verified through documents, such as the borrower’s credit report. In addition, the program is designed to target homeowners who are undergoing “serious hardships”—such as a loss of income—which have put them at risk of default. To participate, borrowers will have to sign an affidavit of financial hardship and verify their income with documents. “If we would have had such stringent verification over the last four or five years, we probably wouldn’t be in as bad a position as we are in,” says Richard Moody, the chief economist at Mission Residential. But while Moody has no objection to such verification, obtaining documents from so many homeowners could be an onerous effort. “It’s going to be a very time-consuming process,” he says. Only loans originated on or before Jan. 1, 2009, are eligible, and modified payments will remain in place for five years. Now that the administration’s plan is out, lenders are free to begin modifying loans.

5. Net present value: To determine if a particular mortgage will be modified, the servicer will perform a so-called net present value test. The test compares the expected cash flow that the loan would generate if it is modified with the expected cash flow it would generate if it isn’t. If the modified loan is expected to produce more cash flow for the mortgage holder, the servicer is to restructure the loan. Howard Glaser, a mortgage industry consultant and a U.S. Department of Housing and Urban Development official during the Clinton administration, called this component of the plan “clever,” arguing that it would work to ensure broad participation. “When you apply the formula, the loans that are modified are the ones that are in the best economic interest of the investors to modify,” Glaser says. “The federal subsidy for the payment on the modification…tips the scale toward modification as a better deal for the investor.”

6. Second liens: The Obama plan also addresses the issue of second liens—such as home equity loans or home equity lines of credit—by offering incentives to extinguish them. But key details on this component of the plan remained unclear. “Distinguishing the second lien is really important,” Green says. “[But] exactly how they are going to convince the second lien holder to do this is not clear to me at all.”

7. Will it work? Moody argues that while the plan may reduce foreclosures for primary residences, it could lead to a spike in defaults for another group of homeowners. Although he supports the administration’s efforts to focus the initiative on primary residences, Moody notes that “it could be the case that a lot of [real estate speculators] have been just hanging on waiting to see exactly what the details are of this [plan],” Moody says. Now that it’s clear the Obama plan leaves speculators out, “we could actually see a spike in foreclosures or at least mortgage defaults among this group.”

Glaser, meanwhile, worries that lenders may soon be overwhelmed by inquiries from homeowners looking to participate. “Starting today, millions of borrowers are going to start to call their lenders to see whether or not they are eligible,” he said. “And I’m not sure that the financial services industry has the capacity to handle these inquiries.”

New FICO Scores

Last month I wrote about the newest version of the FICO score to be installed and available via TransUnion; FICO 08. Since I wrote that article FICO has announced three more new scores to be released some time this month. These new scores and details about those score are;

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FICO 08: The Ins and Outs

On January 29, 2009 TransUnion rolled out and made available the credit-scoring model called FICO 08. This is the newest version of the FICO® credit score, which is simply a redevelopment of their widely used industry standard classic score. The long awaited release of this model is good news for lenders, low risk borrowers, and those with low credit card balances. It’s bad news for piggybackers, companies that sell piggybacking services, consumes with a lot of credit card debt, and the flop of the century, so far, in the credit scoring world known as VantageScore.

FICO 08 will eventually be the industry standard credit score despite not being available yet from Equifax or Experian. We should see FICO 08 at Equifax before the fall and at Experian as soon as they start losing customers to TransUnion or Equifax. Experian has alluded to the fact that their ongoing litigation with Fair Isaac over VantageScore is causing some stress in their relationship and delaying the roll out of FICO 08. The problem is eventually lenders are going to get sick and tired of getting caught in the middle of the “Experian versus FICO” arm wrestling match and move their business elsewhere when they find out that Experian isn’t offering the new gold standard credit scoring model. When that happens you will be able to time the FICO 08 implementation at Experian with the second hand on your favorite watch.

So what is so different about FICO 08 and the other versions of the FICO score? There are three primary differences of note. They are:

1. Negligible Collection and Public Record Exclusion – The newest FICO score will ignore any collections or public records with an original amount less than $100. It’s important to note that for a collection to be bypassed by the score, thanks to the new logic, it has to be reported as a 3rd party collection agency account and not the collection department of a credit card company. If the collection shows up as “trade” then it will still count against your score even if it is less than $100. And, if the original amount was over $100 but it has been paid down to a current balance of less than $100 it will still count in your score. This is exceptional news for consumers who are haunted by low dollar collections caused by misdirected final utility bills and some insurance snafus.

2. Credit Card Utilization – Credit card utilization, the ratio of your current balances to your current credit limits on revolving credit card accounts, remains a highly important factor in your FICO credit score. However, in FICO 08 it takes on a whole new level of importance. Consumers who have balances that approach the reported credit limit will find their scores lower with FICO 08 than with previous versions of the scoring software. FICO’s research has apparently discovered that consumers who are highly utilized with their credit cards are more risky than they were in the past, hence the more punitive treatment.

3. No Piggybacking Allowed – This new version of FICO apparently has the ability to determine if an authorized user credit card account is an attempt to game the credit scoring system through piggybacking, which is the process whereby a consumer with poor credit would pay to be added to the credit card of someone with good credit as an authorized user. Fair Isaac will not disclose how they’re able to tell the difference between a legitimate authorized user account belonging to, say, a husband and wife versus one that has been made it to a credit report through other means, such as piggybacking. You will recall that FICO 08 was originally going to completely ignore all authorized user accounts. This new logic seems to split the difference between ignoring all authorized user relationships and doing nothing to discourage the use of piggybacking services.

So why does FICO 08 pose a problem for VantageScore? It’s actually quite simple. As long as FICO keeps improving what they refer to as their “classic” risk scores the less compelling it is for a lender to test, let alone switch, to a new score brand. Implementing a new version of FICO is much easier than implementing a whole new scoring model, like Vantage. In fact, a company called SubscriberWise has already implemented FICO 08 not more than two weeks after it became available.

The best advice for consumers who will begin to be scored with this new FICO score is for them to continue to do what they’re doing now. Continue to make all of your payments on time. Continue to work down your credit card balances as much as possible. Continue to apply for credit only when needed. If you can do all of these things then your FICO 08 score will be solid as a rock and, who knows, maybe your VantageScore will be solid too, although nobody will care.

Understanding Your Credit Scores

You’ve just applied for a mortgage or auto loan and your lender comes back with a three-digit number that summarizes your credit worthiness and you have no clue what that number really means. What is the difference between a 540, a 670 and a 780? If you’re not familiar with credit scores then these seemingly random numbers can make it difficult to determine where you stand. And in today’s difficult economic environment, you need every point you can get. In this article we’re going to find out exactly...Please sign up or login to see the rest of this page.

Bad Credit Can Cost You Thousands

Bad credit is expensive. A low credit score on a home mortgage can cost hundreds of “points” in interest penalties alone.

For example, say you have an outstanding mortgage of $150,000 - the chart below shows what bad credit means for your interest rates and the ultimate cost of your home equity acquisition. A low credit score can literally double the cost of your home!

Assume you have an outstanding car loan for $15,000. Quick math illustrates the cost of a low credit score. Bad credit can cost you thousands of dollars even on an auto loan!

Let’s assume you are carrying $8,000 in credit card debt. Additionally, let’s assume that you budget $175/month to service this debt. Below are the results of bad credit, average credit, and excellent credit scores on your payment “sundown” and amounts.

As shown, a consumer with bad credit will pay more with higher interest rates, and at a high APR, consumers with bad credit can make minimum payments and yet remain in debt for decades. Bad credit means higher interest rates, period.

Do You Have A Capital One Credit Card?

Boost Your Credit Score

How Delinquencies can ruin your score: Payment History 35%  

Delinquencies on your credit coincide on how punctual you are on making your payments.If you are over 30. days late on a payment it will damage your  credit score. It is always better not to be late on your payments, but-because we are human-we make mistakes or have unfortunate circumstance ( job loss , etc…). But do not despair because there are ways to revamp your score . Here are a few things to consider.  

Timing: The more recent the delinquency, the more it negatively affects your credit score. Let’s say in the last four years you were 30 days past due on a loan payment 3 times, one each in 2004, 2005 and today. The delinquency today will hurt your score a lot more than the late in 2005, which hurt your score more than the late in 2004.   

Level: The later you are on payments, the worse your credit score and the worse your credit worthiness: The rank and effect order is as follows: 30 days is better than 60, 60 is better than 90. Then the progression goes from 90 days late to collections and charge offs, then repossession, foreclosure and finally bankruptcy.  

Past Due Notice:Past due notices have been known to destroy credit scores. Most people believe that they have a grace period when it comes to making payments. For example your mortgage payment is due on the 10th of every month and it says that their will be a $75.00 penalty after the 25th , you can still be over due without being 30 days late , as some mortgage companies are beginning to report past due notices on credit reports , but the next time the mortgage is paid on or before the due date , the previous past due notice will be removed.  

Reducing Your Debt

One of key concepts of turning your financial future around is properly managing your overall debt or better yet reducing it or eliminating it entirely. We here ads all the time on the Radio and TV about settling your debt for less than you owe.

Paying Off Old Collections

As I meet with clients and referral partners across the country, one of the biggest misconceptions I see is that of borrowers paying off old collections in the hopes of raising their credit scores.

Credit After Bankruptcy

Those considering bankruptcy frequently worry that they will never get credit after a bankruptcy, or that it will be 10 years before they can get credit.  Neither is true.  
 
Can I keep a credit card out of the bankruptcy for use later?
If you owe money on a credit card at the time you file bankruptcy, you must list the card as a debt.  Remember, the schedules are filed under penalty of perjury:  perjury in connection with your case can lead to denial of discharge of all of your debts.  It is also a federal crime.  
If you don’t owe anything on the card, you don’t have to give the credit card company notice of your bankruptcy.  Note, however, that they may find out through other means and cancel the card as a precaution. American Express is notorious for this.
Most credit card companies will allow you to keep their credit card for use after bankruptcy if you agree to reaffirm the balance on the card and enter into a new agreement, signed after the bankruptcy filing.  The decision is up to the creditor, but most creditors want to avoid the loss incurred when the debt is discharged, and want your future business. 
Our experience is also that newly discharged debtors are frequently solicited for new cards!

Is my credit record ruined by filing bankruptcy?
In my opinion, bankruptcy is no more harmful to your credit record than the financial circumstances that lead to the bankruptcy filing.  I believe it is much more important for your future financial health to look at your net worth (assets minus debts) than at your ability to borrow in the future.
Most debtors in bankruptcy proceedings, even those who have never missed a payment, couldn’t get new credit from a lender who truly looked at their financial condition.  So the fact that there are no negatives on their credit report is only marginally meaningful when looking at the whole picture.
Bankruptcy at least makes all the debt shown in the negative history unenforceable.  Objectively, a debtor is a far better credit risk after bankruptcy than before. Subjectively, credit managers are individuals who may not understand bankruptcy or look beyond its negative aspects.
Remember that a bankruptcy is not going to erase the record of your debts listed in your bankruptcy.  Credit reporting agencies are within their rights in showing accurate history about your financial affairs.  You want to make sure that the bankruptcy discharge also shows on the credit report so that creditors understand that those old creditors have no legal claim remaining.  Correct any errors on your credit report. 
The point of bankruptcy is to be able to SAVE after bankruptcy, not necessarily BORROW again.

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