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When Home Borrowers Get Into Trouble
Home ownership has many advantages, and also some responsibilities, among them, making required payments on any housing related loans. The two major types of home loans are often defined by their purpose and their term. Mortgage loans are used to purchase a home or property, and are usually extended for long periods of time (15 or 30 years), whereas home equity loans are often used to finance the purchase of a car, to pay for education, for remodeling work, or for other ends, and are typically extended for shorter periods, like five or ten years. There are also home equity lines of credit (HELOC), loans for up to 30 years where the lender sets a credit limit and the borrower decides how much and when to borrow against the equity in the home.
For both mortgages and home equity loans, the property is pledged as security, or collateral, for the loan. For home equity loans, the collateral consists of the borrower’s equity in the home, based on a portion of the mortgage payments that the borrower has already made or, when there is no mortgage, an assessment of the property’s value. Many homeowners have both a mortgage loan and a home equity loan, not necessarily with the same lender.
Mortgage loans are usually first-lien loans, that is, when the mortgage holder fails to make timely payments on the loan, the first-lien creditor (the mortgage lender) has the right to sell the property and receive full payment before payments are made to debt holders with second- or third-liens on the property. Home equity loans are often second-lien loans, but can be first-lien loans when there is no mortgage (the borrower owns the home in full). As is the case with mortgage loans, the home equity loan borrower may lose his house if he fails to make the mandated payments. The rules regarding who gets paid first are very complex. Note that the IRS may be able to satisfy tax liens before the first-lien lender receives payment, and state property taxes may have priority over other claims. State laws regarding foreclosure vary.
After a period in which a home owner fails to make mortgage payments (during which the borrower usually receives a number of letters from the bank), the foreclosure is filed with the court, and the mortgage borrower is served with papers outlining the case against him and a summons instructing him on how to respond to the complaint. A mortgage loan agreement is a legal contract, but borrowers have certain rights, usually a certain length of time to make the overdue loan payments or to pay off the loan in full before the property is taken away. There are also various laws ensuring fair lending practices and anti-fraud laws. Borrowers should contact housing authorities in their state for applicable foreclosure laws. The U.S. Department of Housing and Urban Development maintains a web site directory of approved housing counseling agencies that may be of help.
Borrowers having trouble meeting their mortgage payments have numerous loan workout options nowadays, including an alphabet soup of government loan modification programs under the U.S. Treasury’s Making Home Affordable (MHA) program , that aim to make it easier for borrowers at risk of defaulting to meet their mortgage obligations. They aim to do this by reducing the interest rate on the loan, lowering principal payments, or extending the loan’s term. To take advantage of these programs, borrowers must meet requirements such as fully documenting their income and signing an affidavit of financial hardship.
Help is also on the way for borrowers having trouble repaying home equity loans. A second-lien modification program (2MP) is just getting started. It will lower payments on home equity loans for borrowers who have completed a modification of their mortgage loan under the federal government’s Home Affordable Modification Program.
In addition to the government programs, some banks are taking the initiative in aiding troubled homeowners. In March, Bank of America (BAC) made news when it announced that it would consider reducing mortgage loan principal instead of reducing interest rates on the loans, for certain mortgages for which the market value of the property has sunk far below the mortgage amount.
Will these programs accomplish their mission of keeping homeowners in their houses or apartments? So far, quite a number of homeowners have taken advantage of the programs. Bank of America completed 77,000 mortgage loan modifications in the March quarter, and as of March 31st, 251,000 of its customers were in the trial modification stage under government programs. Another big mortgage lender, JPMorgan Chase (JPM) reported that in the past five quarters, it offered 750,000 trial mortgage modifications to struggling homeowners, and nearly 25% were approved for permanent modification. Still, some home borrowers are having trouble negotiating the qualification process for the federal programs. And it’s too early to know what portion of these struggling borrowers will be able to meet payments on their home loans even after the loan requirements have been eased. Homeowners facing unemployment may have trouble making mortgage payments regardless of whether the payments have been made more reasonable. As long as unemployment remains high, this may continue to be a problem.
Moreover, the banks are encountering difficulties in resolving problem mortgage loans, for example, in the case where the bank holding a first-lien mortgage loan needs to work with the bank holding the second-lien home equity loan in a foreclosure situation. The second-lien lender has little incentive to cooperate if he is unlikely to recover the amount lent. Another problem is that in the past decade, mortgage loans were typically sold and bundled into investment securities. In such cases, the investor, not the bank that originated the mortgage, owns the loan and the mortgage servicer, whose job is to collect the mortgage payments, ends up restructuring the loan. Thus, the complex process of resolving troubled mortgage loans also seems to be prolonging the mortgage crisis.