Loan Modification—or You Can’t Fix Stupid
If you have been following the news on the HAFA program (Home Affordable Foreclosure Alternatives), you may have read that despite millions of taxpayer dollars, this program is not having the results expected. The Wall Street Journal recently reported that one third to one quarter of the homeowners who have modified their loan have managed to keep the loan and their house. That means two thirds to three quarters have not.
Why isn’t it working? Unfortunately, the answer is so simple that you wonder why the program was begun without attention to this detail. Initially, the program did not call for qualification of the borrower with the new terms. Even after loan modification, with interest rates and payments substantially reduced, borrowers had high debt to income ratio—in some cases as high as 62%. This is completely unsustainable.
For those who have entered the real estate business within the past 5 or even 10 years, many have never learned the basics of financial qualification of borrowers. Our industry pretty much handed this over to the lenders, telling our buyers: “Go to one of these lenders, get pre-approved, then I will help you find a house.” Unfortunately, many lenders were predatory, and many buyers got into loans they could not afford.
The basics of financial qualification are not rocket science. For years many agents, including myself, financially qualified our buyers. The traditional ratios for Fannie Mae were 28% and 36%. Both ratios are of gross income. 28% was the most the borrower should pay, from his/her gross income, for all housing costs. This includes: principal, interest, taxes and insurance (PITI) plus any PMI and any homeowner association dues or fees. The upper ratio was the percentage of gross income the borrower was supposed to pay for all debts, including housing costs. So, you asked your buyers what other debts they had—car loan, credit cards, student loan etc and did the math. A high level of consumer debt would reduce the amount available for a mortgage, because lenders insisted (at one time) in keeping the total debt at 36% or less. Even today, in the wake of the housing meltdown, lenders tell me they will “stretch” the upper end ratio to 50%--or beyond—for customers with good credit and down payment. This isn’t really doing a favor to that buyer.
Back to our extreme example—you may never have financially qualified a buyer in your life—but you can see that 62% of a family’s gross income going for debt is unsustainable. HAFA isn’t working, and loan modification isn’t working, because these borrowers are so far in over their heads that the life preserver might as well be made of lead—the borrower will sink with it. Instead of trying loan modifications without checking this important step, the government needs to bite the bullet and let many of these borrowers go into foreclosure. All that is being accomplished now is postponing the pain of eventual foreclosure.
On our side of the industry, we need to quit handing buyers over to lenders and not be involved at all in the process. You need to understand financial qualifying; know how to do the math (it isn’t hard) and talk to your borrowers. Each buyer is different. Some families live more frugally than others. But if your buyers like to eat out at restaurants 5 times a week; belong to the gym, go to the tanning booth, etc. they may look at their budget and determine the loan the lender is proposing doesn’t fit their budget. If you act as a buyer’s agent, one of your fiduciary duties to your client must include keeping your client from financial ruin.
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