Banks are increasingly implementing mortgage modification programs in order both to settle class-action lawsuits and as a way to improve returns on their investments. With housing prices continuing to decline, some lenders have found it increasingly cost-effective to allow borrowers to modify mortgages, rather than foreclosing and having to maintain properties or dispose of them at a loss in a weak housing market. These programs have typically been available only for borrowers who are significantly (usually 60 days or more) behind in payments on first mortgages on their primary residences.
Although the specific features of these programs vary, certain elements are likely to become standard, such as waiving prepayment and restructuring fees associated with mortgage modifications and providing a stay from foreclosure to any potentially eligible borrowers while the programs are implemented. Some lenders have capped borrowers’ monthly payments (including principal, interest, taxes, and insurance) at between 34% and 38% of the borrowers’ gross income. Payments have been reduced by a combination of one or more of interest rate reductions, extended amortizations, and principal forbearance. Some lenders have also limited eligible mortgages to those with certain loan to value ratios.
Banks that engage in extensive mortgage modifications will face several challenges. Since many of the mortgages being modified have been pooled into mortgage-backed securities, obtaining the approval of investors holding the securities has been and will continue to be an important concern for lenders. As well as being reluctant to have their own returns diminish, investors may push to have loans and securities transferred to the Treasury’s Troubled Assets Relief Program (TARP) rather than modified by lenders. Consequently, lenders that participate in modification programs will need to document the modifications properly and provide the appropriate regulatory disclosures. At a minimum, this will include: