I am in financial distress, but my bank refuses to modify my home equity loan. What are my options?
Two years ago, I took out a home equity loan in the amount of $175,000 to be used for a friend's business loan. She walked away from the loan after 14 repayments and left me with the entire debt. I spent $30,000 of my personal income to repay the debt but after two years, I can no longer afford it. I am current on my first mortgage. I filed for a loan modification but was denied. The adjuster asked me to resubmit my documents at the end of September 2010 when my paycheck stubs will show a loss of income in the neighborhood of $14,000 due to educational budget cuts. What do I do in the meantime? Should I do my best to make a minimum payment or move towards a charge off? I am already behind by three payments.
The U.S. Department of Housing and Urban Development offers a succinct definition of mortgage loan modification: "A loan modification is a permanent change in one or more of the terms of a mortgagor's loan, allows the loan to be reinstated, and results in a payment the mortgagor can afford." A homeowner will undergo a loan modification because they are in some sort of financial distress.
Some home loan modifications today are completed according to the rules set by the Obama Administration's Home Affordable Modification Program (HAMP). This is a voluntary program, and there is no requirement that a loan servicer (the bank holding the mortgage in question) participate in HAMP. However, if the loan servicer received TARP money, it must participate in HAMP.
As implied by the definition of a home loan modification, all parties to a loan modification do so voluntarily. A homeowner qualifies for a loan modification according to the value of the loan in proportion to the fair market value of the property, the homeowner's debt-to-income ratio, credit history, and the loan servicer's criteria. A loan modification is not a refinance, does not add or remove a party from the contract, or allow the homeowner to remove equity from the property in the form of cash.
Home loan modification is great in theory, but to date the loan servicers have modified a relatively tiny number of loans that qualify for modification under HAMP. However, a loan modification has several advantages for the consumer and loan servicer. First, although the home loan modification process is unpredictable in terms of timing and outcome, it is rare for a consumer in the midst of a loan modification negotiation to be foreclosed upon. Note my word choice. Bills.com readers have reported that some loan servicers have demonstrated uncoordinated behavior in this regard. Second, a loan modification in and of itself will have no impact on a consumer's credit score.
What you suggest is ceasing payments on your home equity loan, which will cause the loan servicer to transfer the loan from its current accounts file to its bad-debt ledger. The Federal Office of the Comptroller of Currency, in an attempt to prevent banks from inflating future earnings statements with old and defaulted accounts, requires that a creditor write-off/charge-off a debt after approximately 180 days and move the account to a bad-debt ledger.
Allow me to digress for a moment. For the consumer, the only real consequence of a write off is that the account will report as a negative item on the consumer's credit reports. It does not mean that the consumer no longer owes the debt. Despite what it sounds like, an account being charged off does not forgive the consumer for liability for the debt in question. Creditors can continue their collection efforts to secure payment on charged off accounts.
Back to the main issue. Creditors, generally speaking, will not negotiate the terms of a current account. A mortgage modification is an exception to this rule. When a mortgage servicer has several options when it moves a current account to its bad debt ledger. One is to foreclose. Another is to sell the debt to a collection agent, usually for pennies on the dollar. A third option is to task an internal loss-prevention group to try to reach a settlement agreement with the consumer. A fourth is to contract with a collection agent who will try to reach a settlement agreement with the consumer on the mortgage servicer's behalf.
A loan settlement has pros and cons. The pro is that a successful settlement can be for a small fraction of the balance of the loan. The cons are significant. As mentioned, a mortgagee may foreclose if the consumer becomes delinquent. The chances of a foreclosure depend on the individual circumstances of each case. If for example, the creditor holds a second or third mortgage, and the balance of the senior mortgages exceeds the fair market value of the property, then there is no economic intensive for the creditor to foreclose. Second, the creditor may not negotiate reasonably. Finally, because the consumer must default on payments to drive his or her account into write-off status, this fact will almost certainly be reported on the consumer's credit report, which will drive down the consumer's credit score.
Defaulting on payments to drive your home equity loan account into charge-off status is a risky strategy, as I outlined above. However, if the payments are causing you distress, and you are not getting any financial assistance from your now ex-friend, then you must pursue the loan settlement option if your income is cut and making the payments is impossible.
Another option is to file for Chapter 13 bankruptcy, which will allow you to retain possession of your residence and have the lien for the home equity loan stripped from the property. Consult with an attorney in your state who has experience in bankruptcy to learn if this option addresses your needs.
I hope this information helps you Find. Learn & Save.