Millions of people across the nation are facing home loan defaults and ultimately foreclosure.  The foreclosure epidemic has spread throughout every state because of the slumping home sales and mortgage crisis. One popular option that many borrowers are taking to prevent foreclosure is called a loan modification. This refinancing alternative is becoming more realistic for the “average borrower” because mortgage lenders do not want to take on more properties because it has already almost dried up the liquidity of the banking institutions.  The lending companies have come to realize that keeping the homeowners in their residence actually makes the most sense.  Property values have been declining so fast, that the banks will lose more money if they let the foreclosures continue to occur at such a rapid pace.  Foreclosures can be a very costly process for banks and lenders with the average foreclosure costing the bank about $75,000 to sell the home.  Those are costs that are added to the loss from the real estate depreciation.

A loan modification is a revised agreement, in which the lender modifies the current terms and reduces the monthly payment for the borrower.  The primary objective of a loan modification is to restructure the mortgage to a payment that is affordable for the homeowner. Recent state legislation and Congressional initiatives require lenders to make possible every effort to provide loan modifications to homeowners risking foreclosure.

How can a homeowner be sure that they are receiving the full benefit of a loan modification? First of all, borrowers need to learn everything they can about the process of a bank loan modification. Lenders have set up Loss Mitigation Departments specifically to assist borrowers with this option. There are many companies now offering loan modification assistance for a fee. The problem with these companies is they require a large upfront fee with no guarantee of the outcome.  Until recently, mortgage lenders were not proactive in their efforts to help prevent these mounting foreclosures.  The foreclosure epidemic has caused a rift in many families as the divorce rate has increased significantly in the last two years.

A new law enacted on July 8, 2008, now requires Lenders of residential loans in the State of California to accept loan modifications in most foreclosure situations.  California Civil Code 2923.6 went into effect on July, 2008, and applies to all residential loans made from January 1, 2003, to December 31, 2007, inclusive, that are secured by residential real property and are for owner-occupied residences.

Practically all residential mortgages have Pooling and Servicing Agreements (“PSA”) since they were transferred to various Mortgage Backed Security Trusts after origination.  These vehicles likewise almost always contain a duty to maximize net present value to its investors and related parties.  Under the new laws, California Civil Code 2823.6 broadens and extends this PSA duty by requiring servicers to accept loan modifications with borrowers.

Essentially, California Civil Code 2923.6(a) states that “a servicer acts in the best interest of all parties if it agrees to or implements a loan modification where the (1) loan is in payment default, and (2) anticipated recovery under the loan modification or workout plan exceeds the anticipated recovery through foreclosure on a net present value basis.”

Likewise, California Civil Code 2923.6(b) now provides ”that the mortgagee, beneficiary, or authorized agent offer the borrower a loan modification or workout plan if such a modification or plan is consistent with its contractual or other authority.”

So what does all this mean?  Well, lets take an example:

John Martin’s loan is presently in default, or reasonably foreseeable of near default.  The house he previously bought 2 years ago for $800,000 with a $640,000 first and $140,000 second, has now plummeted to $375,000.  While Mr. Martin can no longer afford the $9,000 per month mortgage payment, he is willing, able, and ready to execute a modification of his loan on the following terms:

a) New Loan Amount: $330,000.00

b) New Interest Rate: 4.75% fixed

c) New Loan Length: 30 years

d) New Payment: $1,721.44

While this new loan amount of $330,000 is less than the current fair market value, the costs of foreclosure need to be taken into account.  Foreclosures typically cost the lender $50,000 per foreclosure.  For example, the Joint Economic Committee of Congress estimated in June, 2007, that the average foreclosure results in $77.935.00 in costs to the homeowner, lender, local government, and neighbors. Of the $77,935.00 in foreclosure costs, the Joint Economic Committee of Congress estimates that the lender will suffer $50,000.00 in costs in conducting a non-judicial foreclosure on the property, maintaining, rehabilitating, insuring, and reselling the property to a third party. Freddie Mac places this loss higher at $58,759.00.  

Accordingly, the anticipated recovery through foreclosure on a net present value basis is $325,000.00 or less and the recovery under the proposed loan modification at $330,000.00 exceeds the net present recovery through foreclosure of $325,000.00 by over $5,000.00.  Thus California Civil Code 2923.6 would mandate a loan modification to the new terms.

The homeowner just got a new arrow to add to his foreclosure defense quiver.  Pursuant to California Civil Code 2923.6, the lender is now contractually bound to accept the loan modification as provided above.  Failure to do so should allow the borrower to sue for specific performance or wrongful foreclosure in State Court.   Written by Michael G. Doan