CHAPTER 8

What to Do When Things Go Wrong

THE MORTGAGE DEBACLE in the 2000s changed the way lenders did things forever. It also changed the lives of people everywhere. Lenders are still licking their wounds for all the bad loans they made. In fact, most of the lenders who made all those subprime and alternative loans are out of business. But all too many buyers of those homes found themselves in serious trouble and are still recovering today. Many faced foreclosure right square in the face and won. Some lost.

As a lender makes a loan, the agreement is to get paid back on the first of the month, every month until the note is retired. If the note isn’t paid by the fifteenth of the month, a late payment will be assessed, normally about 5 percent of the payment due.

So far, nothing has been reported to the credit bureaus other than you’ve made your payments on time with no payments being more than 30 days late. Then something goes wrong. You lose your job, or you get sick and can’t work. Maybe someone in your family gets sick and you have to stay home to take care of the person.

Perhaps you have a hybrid mortgage or an ARM that is about to adjust so high that you’ll no longer be able to make payments. Maybe you bought the property with intentions of selling it quickly for a profit without having to make a payment. What happens?

THE FORECLOSURE TIMELINE

After 30 days have passed and the lender still hasn’t received payment, the late payment will be reported to the credit bureaus and your score will drop dramatically. After the forty-fifth day and a payment hasn’t been received, your loan will be flagged at the mortgage company as possibly going into default. Your phone begins to ring from the mortgage company, but you’re not sure what to tell them, so you don’t answer.

So far, you’ve missed one payment. Day 60 goes by, and still no payment has been made. Your loan officially goes into the NOD state, or notice of default. The NOD is required to be sent to consumers notifying them that the lender intends to take back the property or expects to be paid the full amount within 30 days. If after 90 days no more payments have been made, the loan will go into foreclosure.

Different states have different foreclosure rules as to when a loan can actually be foreclosed on, but lenders across the nation follow these guidelines. Note that I said ‘‘guidelines’’ and not requirements.

In the early to mid-2000s, home prices were still on the rise. If a homeowner got behind on the mortgage, he could always sell the property and get out from under the debt. There are closing costs on a sale, just as there are costs when buying a home. The costs can be greater on a sale, primarily due to the commissions earned by real estate agents who list the home. Depending on where you live, agent commissions can be anywhere from 4 to 6 percent or more. There are discount agent services where the agent does little more than place your home on the multiple listing service, but most homes that are sold and marketed properly need a skilled agent.

There are also ‘‘for sale by owner’’ options, or FSBO (fizz-bow), which can save on agent commissions to keep the costs down as well—but again, if you need to sell, you need the experience and marketing techniques that agents can provide. Either way, there are additional costs on a sale not found on a purchase.

Lets take an example of how a sale might take place.

Sales price	$300,000
Closing costs	$20,000
Loan payoff	$100,000
Proceeds to seller	$180,000

Now the loan is paid off and the lender is satisfied. But what if the home doesn’t have all that much equity?

Sales price	$300,000
Closing costs	$20,000
Loan payoff	$280,000
Proceeds to seller	–0–

The seller didn’t walk away with any money, but the burden of the mortgage has disappeared. Now let’s look at this one more time when the loan balance and closing costs exceed the sales price.

Sales price	$300,000
Closing costs	$20,000
Loan payoff	$300,000
Proceeds to seller	($20,000)

This means the seller has to come to the closing table writing a check instead of receiving one. The seller is ‘‘upside down’’ and would have to pay for the privilege of selling his home. But what if the seller couldn’t come up with the $20,000? Or what if the sales price was even less than $300,000 and the seller had to come into the closing with still more funds? After all, if the seller had $20,000 or more in a bank account, he’s likely not behind on his mortgage.

The owner needs to do something or he will lose the house completely and a foreclosure will appear on his credit report, meaning he won’t be able to obtain another mortgage for four years.

SHORT SALES

A short sale is when a bank or lender agrees to accept a smaller amount of money to settle the mortgage account. A short sale isn’t an automatic; lenders hate them. It eats up their assets and they have a house when they’d rather have the money, but sometimes the lender agrees to a short sale instead of foreclosing on a property.

When a home is listed for sale and it appears the sales price won’t be enough to cover the closing costs and loan payoff, you’ll need to begin the process of a short sale. This is difficult to do when working directly with the bank, and I strongly suggest you use an agent experienced in negotiating short sales because there will definitely be some negotiations between you and the lender. There’s a lot to do to convince a lender to accept less than what is owed on the property. Before you contact the lender, you’ll want to gather some documentation.

You’ll Need Documentation to Get a Short Sale Approved

The first is your listing agreement, or even better, a listing agreement along with a purchase contract. There are agents who specialize in buying short sales, so they may have already done their research and have prepared an offer that is offering less than what is owed to the bank.

The listing agreement will show what the home is listed for on the multiple listing service. In addition to the listing agreement, the bank will want to see a comparative market analysis, or CMA, prepared by your agent, which will show what homes are selling for in your area. This is sort of a ‘‘mini’’ appraisal and looks at recent sales data that would support the current values.

Your agent should also provide the ‘‘net sheet’’ which is a tool agents use to show you how much (or how little) you would ‘‘net’’ from the sale of the home. The net sheet on a short sale would show you coming in with a considerable amount of money.

You’ll also want to gather your current financials, such as your bank and retirement statements and your current income status showing copies of pay stubs from your employer.

Finally, you’ll want to compose an explanation letter of why you need a short sale in the first place and be prepared to document your situation. This is your ‘‘hard luck’’ letter that would explain why you are where you are and what you are doing to alleviate the situation. Provide documentation of the loss of income, such as a letter from a previous employer or copies of any unemployment compensation you’re receiving.

Different lenders will have different degrees and types of documentation requirements, but you can expect this list of documentation as a minimum.

Work Out Your Short Sale

Your next step is to contact the lender and track down the ‘‘workout’’ department. Your first contact will likely be with a customer service person who will begin the work on your short sale request, but ideally, you want to work further up the ladder to try and get the name of a supervisor in the workout department.

The workout department is aptly named because it tries to work things out with the borrower. In fact, people from the workout department were some of several people at the bank who were placing calls to you wondering why you hadn’t paid your mortgage. Lenders need workouts as much as borrowers do.

The bank will likely ask for some money to perform a market appraisal on your property in addition to doing its own research on the value of the property from its desk. The bank can do that by reviewing recent sales in your area.

If the bank finds that homes are selling for much more than what you’re selling yours for, then it may not accept the short sale offer. You’ll need to be prepared to respond if they say things like, ‘‘The home down the street sold for $100 per square foot and your short sale request is only $75 per square foot. Why is your offer so low?’’

If a bank thinks it can get more money out of foreclosing on the property and then reselling it, a short sale might not be in your future. If, however, the bank sees that the short sale offer is reasonable and you’re not making any money on the transaction, then your short sale request will likely be approved.

Negotiating a short sale can take time, especially if the bank is understaffed and the requests are many. That’s why it’s necessary to prepare your documentation ahead of time to facilitate the process.

One thing to note here: A short sale request doesn’t have to be made when the borrower is behind on the mortgage. The borrower can be on time every time when the short sale request is made.

Your Request Might Get Turned Down: You Should Know Why

There are several reasons a request might be denied:

• The seller doesn’t qualify due to circumstances. For instance the bank doesn’t believe the story or the circumstances aren’t dire enough to warrant accepting less on the property than what is owed.
• The bank thinks the value is worth more than the listing price. This might mean the bank thinks it would make more by foreclosing and selling the property than by accepting a short sale. There would have to be quite some disparity between the short sale request and the bank’s estimated value, but it’s still not an uncommon reason to decline the request.
• The bank doesn’t own the property any longer. The bank might have sold the loan to another lender or to Fannie or Freddie and doesn’t have the authority to negotiate a short sale.

By addressing these issues beforehand and preparing for them, your short sale request is likely to be accepted rather than rejected.

Short Sales Affect Your Credit

After all, the initial loan terms you agreed to have essentially flown out the window. Do short sales affect your credit? The answer is yes, but it depends on the degree.

Most short sale requests are made by those who are in financial straits. There are current mortgage late payments appearing on the credit report and likely other credit accounts have been damaged as well.

In this instance, a short sale would have little, if any, effect on a credit score, because the real damage has already been done with previous last payments that are appearing.

If, however, there is no negative credit and the mortgage is current, it is up to the lender how it wants to report the short sale. You can make a request to the lender on how to report the short sale, but it’s likely its policy has already been determined.

The credit report might read, ‘‘Paid as Agreed,’’ or ‘‘Accepted Less Than What Is Owed,’’ and a future lender reviewing the report could deem anything less than what was originally owed as a foreclosure. It’s not an automatic, but if you ask ahead of time how it will be reported, you’ll know in advance how your report will read. Different lenders may view short sales differently.

What If You’re on the Buying Side of a Short Sale and Not the Seller?

First, have a little patience, and second, have your own financials in order. Short sales can take an agonizingly long time. I’ve seen short-sale negotiations take months, but if the property is researched thoroughly and all the financials are in order from both the seller and the buyer, then the process will be a smooth one.

What do buyers need? An ironclad approval from their lender of choice, and in a perfect world, an ironclad loan approval from the same lender who holds the current note on the property. You can get this information simply by asking the listing agent who the holder of the note is.

An ironclad approval means your approval documentation has been reviewed and approved by your lender—your pay stubs are in, your bank statements have been reviewed, and your AUS has been issued.

In fact, when you present yourself as an approved buyer, it can also help sway the current lender when considering a short sale.

What if your lender says no to a short sale or you don’t want to sell but make every effort to keep the home? Then you want to look at a loan modification.

LOAN MODIFICATIONS

There are two types of loan modifications: One is for a rate and term change and the other is to modify the current note to make it more affordable.

A rate and term modification has been around for years and is simply a way for the borrower to contact the lender and request a lower interest rate instead of going through the entire refinance process and the associated costs. Now, however, loan modifications have taken center stage and are a key element of a bank’s workout division.

A typical refinance requires the borrower to qualify all over again. If someone has a 7 percent rate and rates drop to 5 percent, the borrower would apply for a refinance loan, supply current pay stubs, and make sure the credit scores are above the minimum and the property has sufficient value in order to make the loan. But if the loan is suddenly unaffordable due to the ARM or hybrid resetting to a sky-high rate or the borrower has reduced income or there is no longer any equity in the property, then a regular refinance won’t work.

A refinance loan will require a minimum of 10 percent equity in the deal. That would mean for a loan amount of $180,000, the property would need to appraise for at least $200,000.

Perhaps the debt ratios are above 50 and the borrower doesn’t qualify because ratios are too high—or even worse, there have been some recent credit issues.

When you first contact the workout department at a bank asking for a loan modification, you’ll encounter a customer service person who will see if you qualify for a workout arrangement over the phone. This arrangement will take any past-due balances and roll them into your loan amount and see if you still qualify from an income basis.

They will ask you how much money you make and go down a laundry list of items that you are currently obligated to pay, not including the mortgage. Car payments, child care, credit cards, even laundry and food expenses will be included.

If it is determined that your income is sufficient to meet your current obligations, then the lender will stop foreclosure proceedings and continue with your workout. This is most commonly used when a homeowner experiences a temporary reduction or elimination of income and thus fell on hard times but has recovered and wants to get caught up on payments but can’t make all the payments at once. You will make a written application after the verbal interview is performed and provide bank statements and pay stubs and so on to complete the process.

If, however, there are some equity issues or your monthly debt load is too much to support the workout, then the loan can be taken to the next level.

If the monthly payment has adjusted so much the borrower can’t afford the payments any longer, even though the income hasn’t changed, then the lender can issue a loan modification. These new loan modification program must meet some criteria, but it’s not as onerous as previous versions.

First, you must be able to qualify with current market rates. If your hybrid or ARM has reset to 10 percent and the new rates are at 6 percent, the lender will run your debt ratios using the 6 percent rate. If your rates are at or below 41 percent, then your loan is eligible for a modification.

You will still need to have a minimum of 10 percent of equity in the property as well if you’re requesting a conventional modification; 3.5 percent equity if it’s a qualifying FHA loan. VA loans aren’t currently available for a VA to VA modification but can be modified with an FHA or conventional loan, given sufficient equity.

The real benefit of the new loan modification programs is allowing for a modification into an FHA loan, which requires less equity. It’s not necessary to stay with a conventional modification. If the FHA loan limits support an FHA modification and your equity is relatively small, then explore the FHA modification program.

What the Home Affordable Refinance Program Means to You

The Home Affordable Refinance Program (HARP), introduced in 2009, addressed the biggest challenges facing homeowners who might go into foreclosure but haven’t been able to modify using a traditional modification program due to equity or credit concerns. As long as the home loan is currently owned by Fannie or Freddie, the loan may be eligible. The HARP program doesn’t ask for a minimum credit score but does require that the home not be in bankruptcy or foreclosure.

HARP addresses loans that are about to adjust into a higher rate or that have equity problems and is applicable if the rate on the mortgage is being reduced or will be lower than what the new reset ARM or hybrid rate will be. There is no minimum credit score on these loans so people with less than a 620 score can still qualify. There’s a catch here, however; if the new payment is more than 20 percent higher than the current payment, the minimum 620 score would apply. HARP was designed to catch those who have seen their property values decline, since there is not enough equity in the property for a refinance.

A HARP loan can go to 125 percent of the current appraised value and still does not need mortgage insurance, even though the loan amount would be more than 80 percent of the value of the home. This means your loan amount to retire the old note could be $105,000, while the appraisal would only come to $100,000. Under traditional methods, a refinance or modification wouldn’t work. Although the LTV can go up to 125 percent and still not need mortgage insurance, the original loan must also not have had mortgage insurance, or the request won’t be HARP eligible.

A HARP loan can’t be a cash-out or equity loan but can only be used to modify the rate and even the term. The term of the loan can be changed as well, as long as the term is being reduced and not lengthened.

Interestingly enough, it doesn’t have to be for a primary residence. If the loan was originally issued as an investment and the HARP request was also for an investment property (the occupancy of the property didn’t change), then the loan is still eligible for HARP.

The program also requires less documentation, as the assets and income are stated, meaning the lender will use what is on the application. This part of the program sounds a little out of whack—after all, wasn’t it the ‘‘stated’’ thing that helped fuel the mortgage mess? But if the rate is being reduced and the payments can be handled, then it makes sense. The key here is to lower the payments and keep borrowers in their homes. In fact, government-backed refinances have had the ‘‘stated’’ feature in their own refinance policy for decades and have been successful at it.

Remember, HARP is for Fannie- or Freddie-owned mortgages only. You might be sending your monthly payments to your lender who is servicing the loan, but it might have been sold to either Fannie or Freddie.

You can look to see if your loan is Fannie owned by visiting www.loanlookup.fanniemae.com, and for Freddie visit https://ww3.freddiemac.com/corporate.

You Don’t Need a Loan Modification Company

As expected, when loan modification gained popularity, then thirdparty loan modification companies began to pop up everywhere. These firms, for a fee, will take your application for you and negotiate directly with the lender on your behalf. Typically, these companies are legal firms, although they don’t have to be.

I recall that when modification companies first gained popularity, I was besieged with e-mails from loan modification companies wanting to tell me, for a fee, how to become a loan modification expert.

Since loan officers are familiar with the loan process, it makes sense for loan officers to act as loan modification experts. On a side note, I find this notion interesting, as I place lots of blame for the past mortgage mess squarely on the shoulders of loan officers putting consumers in loans they never should have had in the first place.

I’ve seen loan modification pitches in e-mails, on postcards, and even door-to-door. It’s a lead generation system, in most cases. The loan modification company hires people to send postcards or letters or e-mails to people who have received an NOD from their lender.

This notice of default is a public record and indicates that the homeowner is having trouble making payments to the lender and might be a candidate for a loan modification.

Sure, they might very well be. But a loan modification request doesn’t have to be made by a loan modification company; it can be made by the homeowners if they so choose.

It is also true that the loan modification company runs through hundreds of modification requests and knows how to structure them properly—allegedly, that is.

The problem I have with loan modification companies is that they typically require a couple thousand dollars up front, with no guarantee the loan will be modified as presented. I also have a problem with loan modification companies when it comes to their competency.

If some people couldn’t make it as (honest) loan officers, then what business do they have working with a loan modification firm? Little, if any, in my opinion.

There are legitimate loan modification companies, I’m sure, but it is hard to tell ahead of time, and it would also be hard to shell out a couple of thousand dollars to someone you’ve never heard of before.

After all, upfront fees are income to these folks with no guarantee to perform. You can fill out some paperwork, send in your $2,000, and then hear, ‘‘I’m sorry, your lender denied your request.’’

You could have done the same thing yourself by calling your lender for a workout, a conventional modification, or HARP loan.

Lenders do not, repeat, do not want to own real estate. It hurts their profitability and can put them out of business. They do everything they can to avoid foreclosing, but oftentimes, the lender has little choice but to move forward.

Want to know one of the biggest complaints I’ve heard from lenders regarding foreclosures? They never hear from the borrowers. They place calls and write letters with no response, and the homeowners don’t think there’s anything they can do, so they just pray and hope something good happens soon.

Lenders, however, don’t know if the homeowner wants to keep the property, and if there’s no communication, the lender will finally assume there’s nothing more it can do.

Lenders pay lots of people money to help their homeowners keep their homes. If you’re someone or you know someone who is struggling, take it from me that picking up the phone and working something out with the lender is the best practice.

Lenders won’t always agree to a workout or the modification won’t work. It’s not 100 percent. But what is 100 percent guaranteed is that the home will eventually be foreclosed on if the homeowner does nothing.

REPAIRING YOUR CREDIT

When homeowners find themselves in difficult situations financially, at some point their credit scores are going to be affected. Since certain minimum credit scores are now required, people who are behind on their mortgage need to do whatever it takes to keep their home, because qualifying for a new mortgage or even finding a place to rent will be difficult due to the damaged credit. So what to do when credit is damaged? Perhaps the best thing to do is simply wait for the credit to repair itself.

When people get themselves in credit trouble, they suddenly notice advertisements for ‘‘credit repair.’’ It’s not that they’ve suddenly appeared. They’ve always been there, it’s just now that they’re being noticed.

Credit repair companies allege they can legally repair your credit and charge you a fee for doing so. Although that may be so, they can only do what you yourself can do and not pay the fee.

Some advise that by placing a consumer letter in your credit report file explaining your situation, your credit will improve. The fact is that lenders rarely ‘‘read’’ a credit report, and instead look at your credit score. You may have written a heart-wrenching letter explaining your situation, but the potential lender will never read it. There is no reason to write an explanation letter to keep on file at the credit bureaus.

Others will, for a fee, attempt to dispute any negative items on your report. Consumer laws require that any disputed item on a credit report must be verified within 30 days or the bureaus must remove the negative items.

This is old school in a new world. If your credit report shows a late payment on your car from a couple of months ago and its valid, there’s not a lot you can do about it other than call up the creditor and ask it to remove the item. The creditor will likely say no, but at least you tried.

What won’t work is continually disputing the same item, hoping the creditor will fall asleep during the 30-day period and the negative information would then be removed.

Since credit scores are reviewed and not the literal reading of a late payment, even if a negative item were removed, the scores wouldn’t change. Credit scores reflect recent activity on a credit report, and unless the credit-reporting agency is specifically asked to ‘‘rerun’’ a credit score without the negative information, the score won’t change.

This is called a ‘‘rapid rescore’’ and is a legitimate method of getting scores up when incorrect information is showing up on a report. I recall a client who needed a minimum 700 score for a second mortgage and her score was 693. It was a 693 because it showed a recent credit card payment being made more than 30 days late.

She got the creditor to document the mistake, providing me with a letter on the creditor’s letterhead. I forwarded that letter to the credit bureau asking for a rapid rescore. For about $30, a creditreporting agency will take the corrected information and then calculate the new credit score as if the negative information were never there.

We did correct the report, her score then jumped to 740, and we got her loan approved.

Credit repair agencies may have had more impact several years ago when things were less automated, but these days it’s nearly impossible to get information that is true and correct removed from a credit report.

What credit repair agencies can do, however, is put you on a path to fix your credit over an extended period of time. But, again, you can do this on your own. If you’re currently experiencing negative credit but you can see your way out of it, here’s how to fix it.

First, stop making late payments. That sounds simple enough, but by putting the bad stuff further and further in the rear view mirror, your score will improve. Because credit scores place the most weight on the most recent two-year period, negative information will soon be in the distant past. That doesn’t mean after 7 or 10 years— getting the bad information on your report as soon as 24 months ago means your scores will begin to rise, as long as you continue making timely payments.

At the same time, make sure you pay your balances down to the magical 30 percent level. If your credit limits are $10,000, then by keeping a $3,000 regular balance, your scores will also begin to improve. If your collection accounts or judgments are simply too many to manage, then perhaps it is time to visit a bankruptcy attorney.

If your situation is a temporary one, meaning whatever went wrong is now fixed, then simply do the things you used to do that got you good credit in the first place and wait—you’ll soon find your scores are where they need to be, and you didn’t have to pay anyone for the privilege.

SUMMARY

• Foreclosures follow a strict timeline, yet states can control certain dates.
• If property is worth less than what is owed, consider a short sale.
• Successful short-sale negotiations require some homework up front.
• Short sales will affect credit reports negatively, but it is up to the lender to decide how to report it.
• Ask for a loan modification if you don’t want to sell.
• Don’t pay third parties to negotiate a loan modification.
• The HARP program was introduced to help people refinance out of their bad mortgage into a lower fixed-rate payment.
• Repair your credit on your own.