By Jack Guttentag
Saturday, November 8, 2008

Q: I have been giving my clients an article you wrote about a year ago advising borrowers having payment problems how to request a modification in their loan contract. Could you bring it up to date?

A: A lot has happened since that column was written. Very shortly thereafter, the Hope Now program promoted by Treasury Secretary Henry M. Paulson Jr. began as an effort by housing counseling agencies and mortgage servicers to modify loans on a voluntary basis. Since then, the first recourse of borrowers in trouble has been to call them at 1-888-995-HOPE. I have sent many people to Hope Now, with mixed feedback.

House prices have declined more in the last year, turning more borrowers "upside down," where they owe more on their mortgage than their house is worth. Some of these borrowers stop making payments, which increases foreclosures. But price declines also reduce the amounts that investors recover from the sale of the house following a foreclosure, which should increase the attractiveness of loan modifications as an alternative.

In addition, a full-fledged financial crisis has erupted. The coverage of deposit insurance has been broadened and money market funds are now insured. There are plans in the works to purchase mortgage assets from investors, to make direct equity investments in banks, and even to insure payment of principal and interest on mortgages and other assets.

An excellent study by Alan M. White, a law professor at Valparaiso University in Indiana, provides some indications of what has happened to modifications. In a sample of subprime loans he examined, the mortgage payment was reduced in only about half the modifications, and the balance was reduced in very few cases. In many cases, the modification consisted of adding the amounts past due to the balance, which raises the payment. It is no wonder that during the period he examined, from July 2007 through June 2008, the number of foreclosures swamped the number of modifications.

For borrowers with payment trouble, the rational choices are either to seek help immediately or to take immediate action themselves. Those who put their heads in the sand will lose their home in a foreclosure.

I suggest that those who elect to seek help go to Hope Now first, and if that does not work out, to try a HUD-approved counselor ( http://www.hud.gov/offices/hsg/sfh/hcc/hccprof14.cfm). Before seeing a counselor, prepare yourself by pulling together all the data that the counselor will need; the form at hoa.mortgageinsurance.genworth.com/FinancialForm can be used for this.

Responding to a solicitation from one of the many modification consultants who have emerged over the last year is extremely risky. They charge $1,000 and up, usually payable in advance. Some may do a good job, but many are hustlers looking to garner upfront fees.

If you elect to handle the matter yourself, you must get to the servicer's loss mitigation department, which may take some persistence. The burden of proof is on you to demonstrate and document that, for the reasons you lay out, you can no longer make the required payment. You must also demonstrate and document that you can make a smaller payment that you specify.

Under the new Federal Housing Administration program called Hope for Homeowners, the FHA will refinance loans of borrowers having payment problems if the existing investor will write down the loan balance to 90 percent of current market value. HUD publishes a list of lenders participating in this program. I am not sure there is any benefit to borrowers to contact one of them before the firm servicing their existing loan has agreed to pay down the balance. But it can't hurt to get that lender on your side.

Some lenders are also reaching out directly to borrowers who are in trouble.

Aside from the possible increased risk exposure under FHA, the federal government has not channeled any crisis money directly to borrowers, although such programs have been discussed. Federal programs could direct $700 billion or more to financial institutions, but none to households. A strong case can be made that this is unbalanced.

The cause of the crisis is the decline in home prices, which will continue as long as the foreclosure problem isn't solved. Arguably, dealing directly with this problem is more effective than dealing with it indirectly.

Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site, http://www.mtgprofessor.com.

Copyright 2008 Jack Guttentag; Distributed by Inman News Features