'Workout' to Prevent Home Foreclosures

Terri Cullen looks at how lenders and borrowers renegotiate mortgage terms to help people keep their homes.
By: TERRI CULLEN: The Wall Street Journal Online
While many potential home buyers are eager to revel at the real-estate party, some homeowners are sobering up the hard way.

Dorothy Monroe is one of many homeowners who took advantage the low interest-rate environment of the past few years to refinance her mortgage and borrow more cash against the equity she'd built in her home. The 60-year-old Wilmington, N.C., resident used her new mortgage to consolidate her debts. "I was making good money then and could easily afford the payments," she says. "But it turned out to be the biggest mistake I've ever made."

After being laid off from her job as a kitchen manager, she suffered a cash crunch that left her unable to make the payments on her mortgage. After three months of missing payments, the foreclosure notice arrived.

Many homeowners who end up in this position resign themselves to losing their homes, but Ms. Monroe managed to avert foreclosure by finding new employment and negotiating a new loan with her lender, known in the industry as a loan "workout."

Workouts can take the pressure off homeowners with bill-repayment or loan-restructuring plans that roll the missed payments into a new loan or allow the borrower to catch up on delinquencies by increasing the amount of a few future months' mortgage payments.

This week, I'll look at how workouts and other tactics can help some homeowners prevent foreclosure.

Understand the Risks

Typically, mortgage delinquencies and foreclosures result from an unexpected financial crisis - a job loss or medical illness that leaves homeowners unable to pay the bills. But now experts are warning that homeowners who - thanks to low rates - have taken on more debt than they should have, face a growing risk of mortgage delinquencies and foreclosures.

Indeed, the first signs of it are starting to emerge. The number of homeowners seeking loan workouts reached 89,741 in the first quarter of 2005, compared with 155,495 for all of 2004, according to the U.S. Department of Housing and Urban Development.

Last month, Standard & Poor's Ratings Services in New York said the risk of defaults is growing on certain adjustable-rate mortgages. These loans initially can lower monthly mortgage payments, allowing some buyers to purchase homes they otherwise couldn't afford. Some borrowers may face increases in their monthly payments of 50% to 90% when the low-rate period ends, S&P warned, and homeowners who haven't planned carefully, or whose income proves insufficient, may default.

"With some of the very unique and potentially risky loan products out there now, and the very high rate at which they're being used, it could turn into the full employment act for loan workout specialists," says Laurie Maggiano, deputy director of the office of single family asset management at HUD.

Evaluate Your Options

If your finances suddenly become tenuous, don't wait until you've missed a mortgage payment to attempt to fix the problem, those in the home-loan industry say.

"It's a very cold, hard world when it comes to debtor-creditor relationships and some lenders can be really tough once they know they have you over a barrel," says Ellery Plotkin an attorney with Cacace, Tusch & Santagata in Stamford, Conn., who represents homeowners facing foreclosure. "Make decisions now while you're still in control."

Get out of a bad situation. If you're a borrower with an ARM that is about to see a rate spike, and you're clearly going to be in over your head, it's time to make some hard decisions about your ability to remain in the home, says Ted Cornwell, editor of Mortgage Servicing News, a trade publication in New York.

Most often people in this situation choose to sell the home and downsize to a more affordable home, or rent, he says. But because mortgage rates have remained so low, he says, homeowners may be able to refinance now to a longer-term hybrid ARM, which combines a fluctuating rate mortgage with a fixed-rate introductory period, or a 40-year fixed rate mortgage.

Consider a "workout." When selling your way out of potential foreclosure isn't an option, it's time to bring in the lender. Ideally a homeowner should contact the lender as soon as it's clear a payment is going to be missed. The clock starts ticking on the foreclosure process after a payment has been delinquent 90 days. Experts say homeowners who reach out early are more likely to succeed in avoiding foreclosure.

Through their loss-mitigation department, lenders may allow homeowners to modify their existing mortgage terms through a workout, to avoid the expense of proceeding with a foreclosure. A foreclosure can cost lenders more than $50,000 in attorney fees and closing costs, according to Ronald Khan, a real-estate attorney in New York.

"Banks don't want to take ownership of homes, particularly in depressed markets where it may take months to sell," he says.

Workouts typically take the form of a bill-repayment or loan-modification plan.

In cases where borrowers have faced temporary financial hardships that they've now put behind them, lenders may allow a portion of the missed payments, say 1/2 or 1/4 of the monthly payment due, to be added to payments going forward, until all the missed payments have been made up. In cases of a current job loss or illness, a homeowner may be eligible for forbearance, where a lender will agree to suspend monthly payments for a period of time, say six to 12 months, until the homeowner can get back on his feet.

Loan-modification programs generally are granted when an individual's financial circumstances have changed for the worse, with no end in sight. They are essentially refinanced mortgages without any upfront costs. The lender may change the terms of the loan entirely, either by extending the loan term to make the monthly payment more affordable, or rolling the missed payments into the mortgage balance to bring the loan current.

Either way, with a repayment plan or loan modification, there generally aren't any direct fees, but the borrower can end up paying more in interest payments on the loan over the long haul. For example, a homeowner with a $250,000 mortgage on a 6% 30-year fixed mortgage who has missed three $1,500 payments could have the $4,500 tacked onto the loan, increasing it to $254,500. The bump would result in the homeowner's paying $5,213 in additional interest over the life of the loan.

It's up to the homeowner to explain what's wrong and work with the lender to come up with a solution. Take a hard look at your financial resources and your basic living expenses, then consider what kind of payments you could realistically make. You'll also need to present your lender with copies of your pay stubs, monthly bills, medical bills and financial accounts and tax records. If you've suffered an illness, a letter from your doctor explaining your condition can be helpful as well.

Above all, be truthful in what you can afford and be prepared to explain how you intend to come up with the money to cover the loan. For example, Ms. Monroe, the homeowner, was able to prove her determination to keep her home by taking on two part-time jobs to cover the one she lost, while she looks for a better-paying steady full-time job.

When a "workout" doesn't work out. If lenders aren't willing to negotiate a workout that you can agree upon, or if you feel uncomfortable approaching the process on your own, consider turning to a pro. Local organizations, such as the regional offices of the U.S. Department of Housing and Urban Development and the Association of Community Organizations for Reform Now may be able help homeowners negotiate workout packages with lenders for little or no cost, or direct them to legitimate, for-profit mediation services.

But beware "foreclosure rescue scams." No doubt by now you've seen the flyers: "We Buy Homes for Cash." The National Consumer Law Center last month released a report showing that scam foreclosure-mediation services are rampant. Read this report to learn more about what to look for, and what pitches to avoid before you start shopping for professional help with a foreclosure.

Finally, even if you're comfortably carrying your monthly nut, take nothing for granted. Create your own foreclosure-prevention plan by socking away at least three months' worth of living expenses to help you weather any short-term financial crisis.