The Math Behind Loan Modification - CHAPA

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The Math BehindLoan ModificationA Webinar for Housing Counselorsand Loan Modification SpecialistsPresented by Bill AllenDeputy Director, HomeCorps

Overview Types of loan modifications Estimating eligibility at intake– estimating Debt To Income ratio (DTI)– estimating Loan To Value ratio (LTV)– estimating the “best‐case” loan modification Understanding the Net Present Value Test (NPV) Understanding an offer– confirming full amortization– post‐modification DTI, a HAMP tier 2 example 2014 Office of the Massachusetts Attorney General

Types of Loan ModificationsFully‐Underwritten Permanent First Lien Loan Modifications: HAMP HAMP Tier 2 Fannie Mae/Freddie Mac Standard Modification FHA loan modifications (including FHA‐HAMP and mods with a “partial claim”) “In‐house” modifications with HAMP‐like underwriting requirementsDistinguish from other “modifications” and related foreclosure prevention options: “Straight‐capitalization” – no change to the contractual terms of the loan Fannie Mae/Freddie Mac Streamline modifications – no underwriting Temporary modification – interest rate returns to the contractual rate after time Forbearance – portion of payment is deferred for a time period but is still owed Repayment – arrearages are paid over time in addition to the contractual payment Refinancing (including HARP and FHA Short Refi) – creates an entirely new loan 2MP – for second liens only 2014 Office of the Massachusetts Attorney General

Review – simplified HAMPmodification waterfall Determine a target payment—31% DTI Capitalize arrearages (increasing the principal balancedue) Change the terms of the loan in the following order totry and reach the target payment – Reduce the interest rate to a step rate with an initial floorof 2% for the first five years– Extend the maturity date to a max of 40 years– Forbear up to 1/3 of the principal, but not more thanenough to bring the interest bearing principal to 100% LTV If the target payment was reached, test the NPV If NPV positive, offer the borrower a trial plan 2014 Office of the Massachusetts Attorney General

The Intake Interview(1) Breakdown of the Monthly Mortgage Payment– You’ll want to know principal & interest (P&I), taxes, insurance, and HOA fees (if any)– A breakdown of P&I is not necessary, but you should ask if the current payment is an interest‐only payment(2) Estimate of Monthly Gross Income by Source–––––“Gross‐up” non‐taxable income by 25% (multiply by 1.25)“Gross‐up” any net income amounts by 25% (multiply by 1.25)“Gross‐down” rental income by 25% (multiply by 0.75)P&L statements: income profit salary /‐ certain adjustmentsUnemployment benefits are not counted(3) Estimate of the Property Value– A recent appraisal is best, but online tools such as Zillow can provide a rough estimate(4) Unpaid Mortgage Balance after Capitalization– If no statement is available, you can roughly estimate the unpaid balance as:unpaid principal (number of months delinquent) x (monthly P&I payment) 2014 Office of the Massachusetts Attorney General

Example #1 – The Simple Family(1) Breakdown of the Monthly Mortgage Payment–––– 2115 principal and interest 300 property taxes 75 homeowner’s insurance 2490 total monthly mortgage payment(2) Gross income by source––––Ms. Simple’s paystub shows: 2300/mo. gross income.Mr. Simple’s SSDI: 1200.Because SSDI is non‐taxable, gross Mr. Simple’s income up to 1500/mo.Gross monthly income 3800(3) Estimate Property Value– Zillow shows: 225,000(4) Unpaid Mortgage Balance After Capitalization– Original 30 year mortgage in May 2007 was 275,000 at 8.5% interest– The Simples paid on time until November 2013, but are now six payments behind. Theunpaid principal is 257,731 10,962 in unpaid interest.– Total balance after capitalization would be 268,693. 2014 Office of the Massachusetts Attorney General

Estimating DTI and LTVCalculate current DTI and post‐HAMP P&I payment Debt / Income 2490 / 3800 0.655 or 65.5% DTI Post‐HAMP Total Payment: 3800 x 0.31 1178 / mo. Post‐HAMP P&I: Subtract taxes and insurance 1178 ‐ 300 ‐ 75 803 / mo.Calculate LTV after Capitalization LTV Unpaid Balance / Property Value 268,693/ 225,000 1.19 119% LTV 2014 Office of the Massachusetts Attorney General

Estimate the Monthly Payment of the“Best‐Case” Loan Modification Where the borrower meets the HAMP eligibility criteria, use HAMP’s programlimits to test your “Best‐Case” loan modification, by finding the lowest allowablemonthly payment using a mortgage calculator or MS Excel formula. If you know in advance the borrower doesn’t qualify for HAMP, for example if theirDTI is already below 31%, use the program limits for the next best loanmodification for which they could qualify, typically HAMP tier 2 or aFannie/Freddie standard mod.– HAMP tier 2: Principal reduced to 115% LTV, 30 yr PMMS rate 0.05% (4.25%), 40 years– Fannie Mae Standard Mod: Principal reduced to 115% LTV, 4.625% interest, 40 years The program limits for HAMP are 2% minimum interest rate, 40 year maximumamortization period, and lowering the interest bearing principal balance to thevalue of the property. For the Simples, we’ll assume they are otherwise eligible for HAMP: 2% rate, 40year amortization, 225,000 interest bearing principal 2014 Office of the Massachusetts Attorney General

Calculating a Monthly PaymentMicrosoft ExcelFunction for calculating a loan payment PMT( rate/12, years*12, ‐principal, ‐balance at maturity) PMT(.02/12,40*12,‐225000,0) 681.36Using a CalculatorP: principal, J: monthly interest rate, N: number of monthsM P * ( J / (1 ‐ (1 J) ‐N)).225000 * ( (.02/12) / (1 ‐ (1 (.02/12)) (‐(40*12))681.36. . . or use one of the hundreds of mortgagecalculators available for free online. 2014 Office of the Massachusetts Attorney General

Compare Results Compare the post‐HAMP P&I to the payment under the best‐case loanmodification. If the best‐case loan mod results in a payment which is less than your estimatedpost‐HAMP payment, the borrower is within the range where they may qualify forHAMP. Again, assuming they meet all the other eligibility criteria. If the best‐case loan mod is more than the post‐HAMP P&I, then you can bereasonably confident the loan servicer will not be able to reach an affordablepayment by modifying the loan and the borrower should consider other lossmitigation options such as a short sale. In the case of the Simples, the best‐case loan modification could reduce their P&Ipayment to 681.36, HAMP only requires that the payment be reduced to 803.So, the Simples may be eligible for a HAMP modification if they meet the othereligibility criteria and the modification is Net Present Value (NPV) positive. 2014 Office of the Massachusetts Attorney General

The Net Present Value Test Compare the present value of the proposed modified loan for theinvestor against the present value of the probability weightedreturns to the investor if the loan was not modified. Neither the HAMP guidelines nor the GSEs require servicers todisclose all of the inputs used in their NPV tests. For homeowner’s with “certain mortgages” who are entitled toreceive a Right to Request a Modified Mortgage Loan under M.G.L.Ch. 244 s. 35B, state law and regulations require the creditor toconduct a compliant NPV analysis, provide the borrower with theservicer’s anticipated recovery at foreclosure, and provide asummary of the NPV analysis along with any denial. 2014 Office of the Massachusetts Attorney General

NPV FactorsModificationPositive Impacton NPVHigher Credit ScoreDecrease in Property ValueScenarioLower Credit ScoreIncrease in Property ValueBorrower EquityProbabilityWeighted Valueof LoanRe‐default‐ loss fromescrow advances and lossModificationfrom foreclosureNo re‐default ‐ Present valueof the new modified loanPositive Impact on NPVAffordability of modificationImpact on NPVNo Modification NegativeScenario‐ProbabilityLoss fromWeighted Value nt NPVNegative Impact on NPVLikelihood of reinstating the loan 2014 Office of the Massachusetts Attorney General

NPV Example, FDIC modelSimple FamilyPresent value of futurecash flow ofmodification paymentsdiscounted by FreddieUnpaidPrincipalMac Rate: 5.4%Balance60%Modification ScenarioNo Modification Scenario(271,436) 206,324 (65,112)(260,062) 144,041 (116,021)0.60 x (65,112)ModificationNo re‐default‐ Present value 0.40 x (117,938)of the ‐ 65,112new modified loanRe‐default‐ lossfromDefault onMod.escrow advances and loss‐ 117,938fromforeclosure(86,242)40%Present value ofPresent value ofloss fromREO propertyforeclosure(255,449) 137,511 (117,938)Re‐default rate and reinstatement rateare creditorofassumptionsspecific toPresent valuePresent anticipatedvalue of REO property suchascreditdefaultescrow advances score85%‐15%0.85 x (116,021) 0.15 x 0ForeclosureLoss fromForeclosure‐ 116,021(98,618)Reinstatement 0 12,376 NPVPositiveNPVNote that even though the bank is losingmoney by modifying the loan, the modelshows they are likely to lose more money ifthey do not modify the loan. 2014 Office of the Massachusetts Attorney General

Understanding an Offer—Amortization Amortization– It’s important to understand whether the modified loanpayments will completely pay‐off the loan by the maturitydate. This is called a “fully‐amortized” loan.– One way to confirm this, is to calculate the fully amortizedpayment by using the interest bearing principal as the loanbalance, along with new interest rate and new maturitydate.– If these inputs result in a payment that is higher than theproposed modified payment, then the loan does not fullyamortize and there will be a balloon payment due at thematurity of the loan. This balloon payment will be inaddition to any payment due as a result of principalforbearance. 2014 Office of the Massachusetts Attorney General

Understanding an Offer—Amortization ExampleUsing a CalculatorP: principal, J: monthly interest rate, N: number of monthsM P * ( J / (1 ‐ (1 J) ‐N))Example Modification Offer: 225,000 interest bearing principal, remaining 43,693 forbearance3.0% fixed interest30 yearsThe proposed P&I payment is a fixed payment of 897/mo.Given these terms the fully amortizing payment should be:M P * ( J / (1 ‐ (1 J) ‐N))M 225000 * ( (0.03/12) / ( 1 – ( 1 (0.03/12)) (‐1*(30*12)))M 948.61So, if the Simple’s accepted this modification. In 30 years, at maturity therewould still be a portion of the interest bearing principal unpaid, in addition to, the 43,693 of principal forbearance. 2014 Office of the Massachusetts Attorney General

Example #2 ‐ Intake(1) Breakdown of the Monthly Mortgage Payment–––– 2015 principal and interest 280 property taxes 85 homeowner’s insurance 2380 total monthly mortgage payment(2) Gross income by source––––Borrower #1 paystub: 4200/mo. gross income.Borrower #2 P&L statement: 200/mo. loss, but draws a 3200/mo. salaryRent one bedroom for 900/mo. Rental income grossed down: 675Gross monthly income 8075/mo.(3) Estimate Property Value– Zillow shows: 375,000(4) Unpaid Mortgage Balance After Capitalization– Original 30 year mortgage in June 2006 was 425,000 with an ARM that adjusted to 11%– Family previously fell behind and had the loan modified to a new balance of 400,000 at 5%interest but have recently fallen behind again.– Recent statement shows the new balance after capitalization of delinquent interest and third‐party fees would approximately 413,000.– The loan is not owned by Fannie Mae or Freddie Mac 2014 Office of the Massachusetts Attorney General

Example #2 ‐ AnalysisCalculate current DTI and post‐modification P&I payment Debt / Income 2380 / 8075 0.295 or 29.5% DTI– At this point you know that it’s unlikely this family will qualify for HAMP tier I becausetheir DTI is already below the target payment– However, given the uncertainty with how the underwriter might treat the borrower’sprofit and loss income, or the rental income, it may be helpful to evaluate the familyunder both tiers 1 and tier 2 of HAMP.Calculate LTV after Capitalization– Unpaid Balance/Prop. Value 413,000/ 375,00 1.10 110% LTVEstimate the “best‐case” loan modification– Using HAMP tier 2 program limits: 4.25%, 40 years, reduce principal to 115% LTV PMT( rate/12, years*12, ‐principal, ‐balance at maturity) PMT(.0425/12,40*12,‐413000,0) 1790.85 / mo. is the estimated payment under HAMP tier 2 2013 Office of the Massachusetts Attorney General

Example #2 ‐ Results For HAMP tier 2, instead of comparing to the 31% target payment,you want to confirm there was at least a 10% payment reductionand that the post‐modification DTI is between 10% and 55%. Postmodification DTI includes taxes, insurance, and HOA fees. Payment reduction:(Prior Payment – Modified Payment) / Prior Payment(2380 – 1790) / 2380 0.25 25% payment reduction DTI range:10% DTI 0.10 x 8075 807.5055% DTI 0.55 x 8075 4441.25 1790 P&I 280 taxes 80 insurance 2150 2150 is well within the acceptable post‐modification DTI range. 2014 Office of the Massachusetts Attorney General

Questions 2014 Office of the Massachusetts Attorney General

FHA loan modifications (including FHA‐HAMP and mods with a “partial claim”) “In‐house” modifications with HAMP‐like underwriting requirements Distinguish from other “modifications” and related foreclosure prevention options: . Refinancing (including HARP and FHA S

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