How to negotiate new terms for your mortgage that stick

By Amy E. Buttell

Loan modification efforts fall short when they aren’t based on what a homeowner can afford in the long run.

The good news is that the number of loan modification efforts designed to help financially troubled homeowners remain in their homes is up; the bad news is that more of the same homeowners who received a loan modification are in default again.

What’s the problem? Many loan modification efforts are falling short because they aren’t based on what a homeowner can actually afford in the long run, making re-default on the loan almost inevitable. The number of unsuccessful loan modification attempts rose 9 percent to 51.3 percent from the first to the second quarter of 2008, according to data from the federal Office of the Comptroller of the Currency.

“Loan modifications are good for some, but pretty bad for others,” says Greg Rand, managing partner of Prudential Rand Realty in White Plains, N.Y. “There are some people who are better off dumping the house and getting the albatross off their neck.”

Loan modification strategies that work include:

Basing new payments on true income. “The best way to figure out an affordable payment is to look at your income and take a reasonable percentage of it and have an amount no more than that be your new payment,” says Louis Spagnuolo, chief executive officer of Modifications.com, a company that assists homeowners in the loan modification process.

By documenting your income with several years of income tax returns, your mortgage servicer can establish an affordable payment that will not adjust upward, which makes it more likely you can stay in your home long-term.

Typical mortgage payment ratios range from 31 to 38 percent of income, according to Michael Ashley, chief business strategist of Lend America, a mortgage lender and participant in the federal government’s Hope for Homeowners mortgage modification program. When a payment is no more than 38 percent of your income, you can more easily meet your other financial obligations.

Permanently changing adjustable-rate loans into fixed-rate loans. Many of the borrowers who at biggest risk for foreclosure are those with adjustable-rate mortgages, particularly those with option ARMS, in which borrowers can choose how much to pay each month — the least expensive payment option covers only the interest due; the principal increases.

If you can get your servicer or lender to agree to a loan modification that converts your adjustable-rate mortgage into a market-rate fixed rate (the rate that prevails in the market, like what you could get from a bank, not a really high fixed rate), you will know your exact payment amount going forward and be better able to budget for it. A temporary rate reduction resulting from a modification won’t help when your rate climbs back up.

Forgiving past balances. A loan modification that adds past balances to current balances generally doesn’t work, because you end up owing more money for a longer period. “The scary loan modifications are ones where the bank lets you pay less and adds the difference to your balance owed,” says Rand. “They call that negative amortization. I call it debtor’s prison.”

One reason why many loan modification efforts fail is that overdue payments are added to the loan balance with no other modifications made to the loan, so the payment and terms are the same and the overall balance is larger.

Extending loan terms. In some cases, lenders or loan servicers will extend a loan from 30 to 40 years to lower the payment and make it more affordable, says Spagnuolo. This can be beneficial, but realize that a longer amortization schedule means that you will pay more overall in interest charges. However, if this is the only way you can avoid foreclosure, it is an option worth exploring.

Reducing balances. Many homeowners who are at risk of foreclosure are upside down on their loans due to the plummeting real estate market. Millions of homeowners owe more on their homes than they are currently worth.

“A good loan modification is one where the value of the loan is less than the value of the property,” says Ashley. In some cases, this means getting a lender to write down or write off the value of a second mortgage or home equity loan on the property so that the overall balance is reduced.

When working with your lender or loan servicer towards a loan modification, be patient and persistent. Keep records of all of your phone calls, letters and emails, and all the communications that you receive in the mail. If you need help, work with a certified consumer credit counseling agency, such as the National Foundation for Credit Counseling’s Homeowner Crisis Resource Center, an agency affiliated with the Hope for Homeowners program, or an attorney with special expertise in loan modifications or bankruptcy. You can find tips and bankruptcy attorneys in your area through the National Association of Consumer Bankruptcy Attorneys.

And avoid foreclosure rescue scams, where scam artists promise you a loan modification but actually take your money without giving you any help. The Federal Trade Commission provides tips on how to recognize these scams.

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