Tuesday, August 7, 2012

How HAMP Loan Modifications Work


In 2008, the federal government rolled out a program called the "Home Affordable Modification Program" or "HAMP". The program pays lenders to work with homeowners. However, the compensation is not very much (especially when compared to the free bailout money). Many homeowners still do not understand how HAMP works and become agitated when the bank representatives themselves can't explain it. If you have been offered a HAMP modification, it is important to know how it works so you can decide what to do.

The modification application requires the lender to review financial documents from homeowners. These documents are then used to figure out what terms are possible under HAMP using a Net Present Value test, also known as the Waterfall.

The first thing the lender needs to do is figure out their investors' interest rate limits. Since most home loans in the U.S. belong to Freddie Mac or Fannie Mae, you can usually find the weekly interest rate "floor" and "ceiling" online. For purposes of this blog only, let's assume that the floor is 3.0% and the ceiling is 4.0%. This means that the lowest interest rate that one can expect from a HAMP loan mod is 3.0% and the highest is 4.0%, although ultimately, everyone will end up paying the 4.0% (explained below).

The lender then goes through a "waterfall" test based on government guidelines to calculate the optimal loan mod scenario. Since the lender is going to submit the application to the government for compensation, lenders have strict rules to follow. It is a mistake for borrowers to assume that HAMP loan mod terms are negotiable

Let's go through a waterfall test in its simplest form.


Assume that Alfred, a single man in Washington state, makes $3,500 per month. When he bought his home in 2008, it was worth nearly $365,000. Today, it is worth about $200,000 if he can sell it. The unpaid balance on his loan is $300,000; with an interest rate of 6.5% fixed for 30 years, Alfred's monthly payment is $1,896.20 not including property tax, insurance, and homeowner's association dues. He is currently 15 months behind on his payments and foreclosure is imminent. Assume also that Alfred can show hardship (that is, he didn't simply choose to work less hours and have medical problems). If Alfred is to apply for a HAMP loan modification, what results can he expect to see?

Original balance
Unpaid balance
Property value
Monthly income
Current interest
Current payment
15 months

Waterfall test #1: Reduce the monthly payment to 31% of borrower's income

     $3,500 x 31% = $1,085/month.

If Alfred's payment is reduced to $1,085/month, his interest rate would be lowered to -0.60%. That interest rate are WAY below the floor rate (3.0%), the lender is required to move onto the next test.

Waterfall test #2: Extend the loan term to 40 years

$1,085 at 40 years yields an interest rate of 1.3%. This is still below the floor rate thus, the lender is required to move onto the next test.

Waterfall test #3: Apply principal forbearance

A principal forbearance means that some of the principal balance is not going to be charged interest. The lender starts with 4.0% (the ceiling rate) and start to decrease the interest in small intervals until it hits the floor. The idea to minimize the amount principal forbearance without cutting too much interest.

Here, Alfred would require a principal forbearance of $80,019.97. This means that the lender would waive the interest on this part of the loan. Usually, this means that Alfred will have a balloon payment of $80,019.97 at the end of his loan term. [Most people do not know about this].


New Loan
for first 5 years
for first 5 years
after 5 years
after 5 years
Balloon payment
at end of loan
40 years

Alfred's loan would be modified to 3.0% on $219,980.03; 0% on $80,019.97. The 3.0% will increase to 4.0% (ceiling rate) at month 60 (5 years) and then remain at 4.0% until the end of his loan term. That means that his loan payment will be temporarily reduced to $$920.33/month for the first 5 years; after that, it will be $1,050.64/month. At month 451, he will receive a bill for $80,019.97.

The net benefit of this modification to Alfred is a saving of $975.87/mo during the first 5 years and a saving of 845.56/mo after that.

Thus, no matter what interest rate the loan is temporarily reduced to, the end result is that everyone will pay the ceiling rate (at the time the loan mod applications was approved) after 5 years. Fortunately, the ceiling interest rate is low enough that most people won't complain.

If you are a Washington State resident who needs assistance reaching out to the bank, my office represents homeowners in foreclosure mediation, where we are able to apply for a loan modification directly with the lender. This reduces communication congestion and paperwork nightmare that most borrowers go through during the loan review process. Mediation also allows lenders to look at alternative loan modifications. Since only attorneys and HUD Counselors can refer homeowners to mediation, homeowners are advised to speak to one ASAP since timing is crucial to a successful mediation.

Contact Arrow Law Group at (206) 467-1785