Sunday, November 14, 2010

Loan Modification Budget Strategy -DTI Goals!

How lenders interpret the loan modification guidelines and how to develop your modification budget strategy.

The key to a successful loan modification boils down to math. Different banks also interpret these guidelines differently. The main problem homeowners have in applying themselves is not knowing these rules. So get your budget out and work up your numbers. Drill them into your head and be prepared to deliver supporting documents every month that match your strategy if you expect to succeed.

After the hardship letter
As I have stated in previous posts, the number one qualification to apply for a loan modification must be financial hardship which has impacted your ability to meet your current payments using this Debt to Income test. These factors may be temporary or permanent so the hardship affidavit (letter) is your starting point, followed by your budget analysis.

Regardless of whether you are applying for a HAMP, MHA or HARP or private  bank program;  they all share one focus: a prescribed level of affordability. The basis is to quantify and verify your debt to income ratios fall into a safe zone of risk.

We use a simple calculation to calculate Debt to Income:

DTI = Monthly Mortgage Payment DIVIDED by Your Gross Monthly Income.

Front end debt to income ratio
Your 'front end ratio' is JUST your housing expenses, including mortgage, insurance and taxes. If you are distressed, your DTI will be between 35% and 60% to basically fall into the danger zone. Most lenders allow 45% for a mortgage. So if you are at 45% DTI now, and have experienced a financial hardship for a mortgage transaction that was completed prior to February 2010, congratulations -- you may qualify for a loan modification.

If it were just that simple. It isn't.

Example: current mortgage payment, including taxes and insurance, is $1,250 divided by monthly income of $4,000 per month  = 31.25% DTI.

Most banks use gross monthly income to keep things simple.

It just so happens that according to the affordability indexes of these programs, 31% DTI is the safe zone target. So if this is your current situation, you are already living within your means and will not be considered for a loan modification. Save yourself the trouble, time and anxiety of trying to get help because you will be turned down. A lower number means you are even safer territory. Above 35% and its starting to approach a qualifying level, based on other compensating factors of your case.

Back end debt to income ratio
Next work up your scheduled debt to income ratio-- which includes your mortgage plus all your credit cards, car payments and regularly reported credit. This needs to be under 70% total. In other words if you have more than 70% going out the door every month they will worry how the heck you will survive even with a modification since these debts are not going to be paid down if you can only make your minimum payment.

Example: $1,250 mortgage payment + $300 car payment + $300 minimum credit card payments + $200 Student Loan = $2,050 divided by $4,000 = 51.25% DTI. This is considered a risky DTI. A 70% back end ratio would be considered  EXTREMELY risky because when you add your scheduled credit payments, PLUS basic living expenses (all fixed costs which are unlikely to go down) a major car repair or injury could wipe you out.

Sometimes a dual strategy is employed to consolidate your debt--but that is another subject for another day. Depending on the lender, this may be a good thing or a bad thing.

What does DTI establish?
Risk. Essentially, your DTI establishes how much assistance or 'break' will be necessary to get you into a safer risk category. The current front end, current back end and cured front and back end DTI ratios are compared and negotiated once all your facts are established.

Imminent 'risk of default'
Your must basically PROVE you are in danger by showing DTI's currently over 35% and under 70%. Then you must make a case for lowering your front end DTI to 31%.

Loan amount $250,000 at an interest rate of 7.5% = PITI (principle, interest, taxes and insurance) of $2,008 per month divided by $4000 income =  front end DTI of 50.20%. High by any standard.

Now reduce the interest rate to 2.5% = PITI of $1,248 per month = 31.2% DTI. Perfect!

You see where we are headed?
Getting your payment into a safe zone -- even for a few years so you can recover financially is the goal. Officially the HAMP and MHA programs aim for five years relief, but most banks allow to 30 year improved terms. They figure most people move on average every 7 years so they are just protecting their losses by keeping you in your home and paying them something on all their cheap TARP money. You will have to negotiate very strongly if you are representing yourself. Above all, keep your cool and be polite if firm.

The winning strategy:
The goal is to establish what level of risk is acceptable to your bank and head for that zone as your negotiating point. If you are too far over into the danger zone due to high debts or your income is unlikely to qualify (either too high or too low) then you may as well call it quits right now.

If your income is likely to improve, or you are recovering from injury, career change, etc., you may still have a chance to make your case and meet this zone. In some instances I know borrowers who merely stalled during the application process until their income was acceptable. You may just be buying time. It's pretty stressful work to negotiate this yourself while you are attempting to rebuild your business and career. I strongly recommend you hire an advisor.

The winning tactic:
Use an amortization chart and plot in your mortgage loan amount and fiddle with interest rates until you get your PITI payment down to 31% DTI using your current income. If you are short, you can see how much income you will need to qualfiy to get up to 31% DTI. Use 2.0 - 2.5% as a floor interest rate for starters.

Expect to see a rise over a 5-10 year period to say 4.5 - 5.0% and then argue to fix that for the remaining 20-35 years. Yes, they will offer 40 year terms if that's what it takes. In rare cases, if you are way over the save DTI zone, and they really don't want your underwater property, some lenders will set aside a chuck of your loan in an interest free second lien that must be paid when you sell or in a certain balloon time frame. Hey - it's free money!

Budget wizardry
If you are waged, it will be easier to show consistency of income by providing your pay stubs. If your hours are inconsistent, you can average your income over several months and include funds from liquidating any assets or extra cash work you may scrounge up to support your case. After all you are working on financial recovery. Show recovery and stability.

If you are self employed, you must provide your corporate Profit and Loss and both corporate and personal bank account statements. Now might be a great time to hire a bookkeeper or take some Quick Books training. Naturally you need to show a clean separation between business and personal. If you need to show more of your net income going to yourself to meet the minimums, you can take owner draws. It's a balancing act. Just aim for consistency in your budget from the start. They do check along the way! You will be coughing up reams of account statements, tax returns, pay stubs and profit and loss statements every month. If anything show a little improvement. Going backwards scares the beejezus out of banks.

Did I mention this is not a great time to take a cruise or buy a new car? Any new debt or time off work will absolutely kill your chances of loan modification.

Extra hint:
To support your hardship, you should ideally show very little money left over every month after making all your combined living expense payments.  Once your housing expenses and scheduled debt, including food, insurance utilities, clothing, etc are paid each month, you want maybe $100 left over. If you suddenly start stacking up extra money in your savings this may indicate you no longer need help. You lender will verify your bank account balances directly.

What about missed payments and arrears?
Since your bank has every legal right to expect those interest payments you agreed to pay back in your promissory note, any shortfall or 'arrears' will eventually arrive in the form of a higher loan balance or longer term. Normally they forgive any fees associated with late payments. Don't worry -- the goal is to keep you in your home and if your case is well documented and meets both hardship and DTI test, you have a good chance of being offered a loan modification.

What about your home equity?
Even if you think your home value is holding up, it's not a great idea to admit you have much equity when you are applying for a loan modification. You may mention any deferred maintenance and state your value close to or below your loan amount. It concerns me that certain banks have been VERY aggressive toward clients with obvious home equity.

You know you are getting close when
At some point when your application is nearing a decision, the lender will send an appraiser to perform a Broker Price Opinion or BPO and report back to the bank. I know one fellow who parked old junker cards in his yard and let the grass grow. By the way, I've had clients report people arriving without notice claiming to be from 'your bank'. It is likely they got your address from the county foreclosure list. A real bank appraiser will offer their card and know who your bank is -- they rarely ask to come inside. Refuse intrusion.

If you decide to negotiate your own loan modification and these tips were useful I would be pleased to hear your results. Otherwise, your professional adviser will employ these or similar strategies on your behalf. You can appreciate their effort is not easy or clear cut.

All the best! equitytalks

© 201 susan templeton
*Susan Templeton is not a loan modification advocate