As an attorney, I see the end result of bad investment decisions.  As an investor, I’ve made a few of my own.  Naturally, I wonder how these mistakes could have been avoided.  Would a better understanding of the psychology of investment decision-making  decision process help the investors avoid unnecessary losses?

Dr. Meir Statman, who holds the Glenn Klimek Chair as Professor of Finance at Santa Clara University Leavey School of Business, has written extensively on the topic of behavioral finance.  In a recent (Aug 23) article in the Wall St. Journal, “The Mistakes We Make - and Why We Make Them,” Professor Statman highlights the emotional impact of our tendency to avoid the “pain of regret.” Professor Statman theorizes that the tendency to hold onto a losing investment longer than necessary is caused by the need to avoid facing the reality that the investment has lost value.  As a result, the investor loses even more, even to the point of holding onto the investment until it has become worthless.  Professor Statman also notes the human tendency of investors to focus on realizing gain, which sometimes leads investors to sell a good investment prematurely.

In the WSJ article, Professor Statman provides eight “lessons” as a guide for investors to control these otherwise “normal” human tendencies that tend to adversely affect investment decisions.  He notes that “most investors are intelligent people, neither irrational nor insane.” But, the study of behavioral finance shows that we are subject to emotional influences that cause us to make decisions that are sometimes smart, and sometimes stupid.  “The trick, therefore, is to learn to increase our ratio of smart behavior to stupid.”

Most of Professor Statman’s examples focus on investments based on the stock market, which provides a convenient laboratory for studying reaction to changing conditions on a fairly rapid basis.   Would these rules apply in the world of real estate investments, where the valuation is based on different criteria, and the frequency of changes in value — at least in relative terms — is much much slower.  I would theorize, however, that the emotional factors are at least as strong as those associated with the buying and selling of stocks, in most cases.

Professor Statman’s lessons and his examples are worth reading.  Briefly summarized, he cautions against attempting to time the market; not to mistake hindsight with foresight; don’t let the fear of the pain of regret make you hang onto a losing investment too long; don’t just focus on success stories; avoid being driven by fear or exuberance; recognize happiness comes from gains in wealth, not levels of wealth; and to distinguish loss of wealth from loss of ego.  Professor Statman argues for diversifying your portfolio and using dollar-cost-averaging as a smart strategy to reduce regret and avoid losing your mind.

How could these lessons be applied to real estate investing?  The first lesson — avoid trying to time the market — is counterintuitive.  Aren’t you supposed to “buy low, sell high?”  In real estate, as in the stock market, there is a tendency to chase the market; to follow rumors and hype.  Following the herd is obviously a bad strategy for many reasons, but time and time again, you’ll hear someone say “So-and-so said on CNBC that Las Vegas/Miami/Phoenix was going to be the next hot market.”  Worst yet, people will claim to avoid chasing rumors, but pay thousands of dollars to so-called real estate “gurus” who will divulge a “secret” to the audience, and off they go.  Unless you are adding to an already diversified portfolio, chasing the “next best deal” is simply foolish.

Confusing hindsight with foresight is common, but could be disastrous.  Professor Statman states that “Hindsight error leads us to think that we could have seen in foresight what we see only in hindsight.”  Yogi Berra put it bluntly:  “Making predictions is difficult, especially about the future.”  A forecast is just a prediction, and investment involves making an educated judgment about the future.  Just because a particular author or speaker claims to have made an accurate prediction does not guarantee that their next prediction will be any more successful.  Statistically, each new flip of the coin presents a 50% chance of heads or tails; success or failure.  The danger here is overconfidence.

Professor Statman, an expert in the field of behavioral finance, notes that ‘Emotions are useful, even when they sting.”  The tendency to avoid the pain of regret leads to hang onto a poorly performing investment with the false hope that it will recover, rather than face the actual loss that will result when the investment is sold or abandoned.  He urges investors to not “cry over spilled milk,” and start thinking about today and tomorrow; and not focus on regret.  Hanging on to a losing investment only postpones the inevitable and magnifies the pain.

Another lesson involves what Professor Statman refers to as “confirmation error,” whereby we focus only on successes, and look only at evidence that supports or confirms the favorable outcome.  By way of example, Professor Statman notes it is human nature to focus on the miniscule, statistical probability of winning the lottery, and ignore the fact that the vast majority of participants lose.  In any truly diversified real estate investment portfolio, there will be both winners and losers, and within the range of winners, there will be both big and small returns.  The question will be whether the winners, taken as a group, outweigh the total losses, for a net gain, but human nature is such that the focus will be only on the one, super-successful investment deal in the entire portfolio, and the tendency to mischaracterize the entire portfolio as performing at the level of the single biggest performer.

Professor Statman makes the seemingly obvious observation that one should not base their investment on either fear or exuberance.  Again, he cautions against trying to “time the market,” and resist the temptation to be motivated by either a fear of losing your shirt, or the exuberance of jumping on the bandwagon.  Similarly, he advises investors not to lose sight of your goal.  Professor Statman says a stock market crash is like an automobile crash.  The key is to focus on whether you can drive to the garage, or need a tow truck.  I would add whether you need an ambulance.  The point here is to recall what goal you were trying to reach, and evaluate what you need to do after the accident to get back on track.

Last, but not least, Professor Statman is a strong advocate of dollar cost averaging.  This strategy is well known as applied to the stock market, where the daily price fluctuations and unpredictable nature makes it almost impossible for the typical investor to outguess the market, so making regular and consistent purchases will balance out the “per share” cost over time, and hopefully reduce the regret factor.  Here, I will take a leap and suggest that Professor Statman’s “lesson,” applied to real estate investing, would argue for building a diversified portfolio of different types of real estate investments in different geographical markets, as a hedge against a total failure should any one type of real estate or any particular market suffer a significant decline in value.

The bottom line is we need to learn to increase the ratio of smart decisions to stupid ones, and recognize that the latter are often the result of emotional factors that we failed to recognize or control.  Doing one’s due diligence, fact-checking, and staying focused on your personal and financial goals, are all important considerations for the real estate investor.

Yet another study — this one released last month by the Federal Reserve Bank of Boston — serves only to reinforce what we already know:  lenders were reluctant to modify existing loans during 2007 and 2008.  (Wash Post, 7/27/2009).  Although some 1.5 million borrowers were subject to some form of foreclosure filings during the first half of this year (2009), only around 200,000 loan modifications have been issued since March, when the Administration launched the new Making Home Affordable Guidelines.   Part of the difficulty in evaluating the data is that many lenders have only very recently begun to apply the new Guidelines, while study after study focuses on statistics from 2007 and 2008.  Part of the reason for the sweeping new Guidelines was to remedy the shortcomines of the previous programs.

The Washington Post reports that “Modification makes economic sense … only if the borrower can’t sustain payments without it” and the modified terms will allow the borrower to keep up.  Duh.  Another brilliant conclusion:  Borrowers who are likely to fall behind even if the loan is modified are not a good candidate for loan modification.   Double-Duh.  And this:  Lenders have little financial incentive to help delinquent borrowers, who with extra effort and a little luck, can catch up without a modification.  Well, you get the gist of it.  I hope they didn’t spend a lot of money on that study!  If we only had solid information like this back in 2006, we might have been able to avoid the whole problem, don’t you think?

Compounding the issue is a fundamental lack of critical knowledge:  is it more economically advantageous for lenders to foreclose or modify?  Even the Washington Post can’t make up its mind:  the headline says “Foreclosures are Often in Lender’s Best Interest.”  Then, they quote Laurie Goodman, senior managing director at Amherst Securities, saying “In some cases, lenders lose twice as much foreclosing on a home as they did two years ago.”  Apparently, falling housing prices — often a direct consequence of foreclosures — cause lenders to lose money in foreclosure sales.  Go figure.

So, did we learn anything from the Boston Fed study?  Well, we learned that only a small percentage of loan mod applications are actually being approved, as lenders are only just now starting to apply the new Guidelines.  The study seems to confirm what we suspected — lenders are focused on their bottom line, not the borrower’s.  Lenders are working on finding the right balance of when would be the most optimum time to proceed to foreclosure based on the projected price bid they can get.  If the loan mod will only delay foreclosure and housing prices continue to drop, it only makes sense to deny the loan mod and proceed to foreclosure.

Sadly, this often comes as a bitter blow to the hard working borrower who is just trying to get a temporary reduction in their monthly mortgage payment, either through a rate adjustment or an extended term, so they can meet expenses and catch up.  Where home values have dropped significantly below the amount of the loan, and the lender refuses to make a meaningful modification, the borrower has little incentive to keep the house.  The result — absent any intervening factors — will be more foreclosures, further reducing prices, and causing lenders to prematurely panic and sell before the prices drop further.

Obviously, this will not work.  The Treasury and HUD have summoned industry executives to a meeting to discuss how increase the pace of loan relief.  It would seem that if more loans could be modified, even if only temporarily, there would be fewer foreclosures and less downward pressure on housing prices overall, not just for foreclosure properties.  Achieving stability would be a good objective, but we still have not seen any studies of the application of the new Guidelines.  Maybe if we had some relevant information, we might gain some relevant knowledge.

Another day — another study.  Stan Liebowitz, professor of economics and director of the Center for the Analysis of Property Rights and Innovation at the University of Texas, writes in an op-ed piece that “the most important factor related to foreclosures is the extent to which the homeowner how has or ever had positive equity in a home.”  He says that his analysis of foreclosure data shows that subprime loans, upward resets, and so-called “liar loans” were not the primary cause of the current foreclosure crisis, and hence current government programs are “misdirected.”

It is interesting to note that Professor Liebowitz’ analysis concludes that 51% of all foreclosed homes had prime loans.  He reports that his analysis of foreclosures during the second half of 2008 shows that while 12% of the homes had negative equity, they accounted for 47% of all foreclosures.  Professor Liebowitz’ reasons that negative equity, by itself, is not an indicator of a foreclosure, but it implies that the borrower is more likely to walk away from the loan.  He argues that current government programs (i.e., Making Home Affordable), and federal efforts to keep interest rate low, are misdirected.  Driving mortgate payments down to 31% of income will not have much of an effect, since his study showed that those with higher (38%) ratios were not more likely to face foreclosure.  Reducing interest rates induce refinancing, not home purchases.  Professor Liebowitz calls for stronger underwriting standards, higher down payments, and clarifying the consequences for homeowners who simply choose to “walk away.” The good news, according to Professor Liebowitz, is that housing prices are approaching a long-term, pre-bubble levels and equilibrium.  He singles out Barney Frank for criticism for efforts to artificially increase homeownership levels, which would delay the return to equilibrium levels.

Professor Liebowitz’ analysis is one of many that will be conducted as the data becomes available, and it will be interesting to see more precisely what will actually work.  Empirical evidence suggests that while we’re still headed downhill, and the forecasts for continuing foreclosures are dramatic, it is probably too soon to know more precisely what the actual causes of the crisis were, thus too premature to fashion a realistic solution.  We know that many of the investors currently holding the notes are largely unwilling to make significant concessions in terms of rates or payments, let alone reduce principal.  We know that rising unemployment will continue to threaten the pace of recovery — if we’re even in the recovery phase at this stage.  We know that lenders aren’t lending, despite billions of dollars already spent by the Federal Government.  And, we’re starting to see the first real wave of the crisis hitting the commercial property markets, where it will be difficult to scapegoat any single demographic factor as a cause.

Professor Liebowitz is correct when he says that “Understanding the causes of the foreclosure explosion is required if we wish to avoid a replay of recent painful events.”  That goes without saying.  But we just finished the first half of 2009, and studies of what happened during the last half of 2008 may — or may not — tell us all that we need to know.  We really need more analysis, more action, and less knee-jerk legislation.  Private lending has the potential to fill the gap left by the credit crunch, but there is room for mischief and abuse, and the banking industry lobby is fighting hard to protect its grip on the supply.  Ultimately, Americans have proven to be resourceful, creative and most importantly, survivors.  The current rush of legislation at the Federal and State levels are based on old data, driven by special interests, and may cause more harm than help.  We need to be a bit more patient and get better data before we inadvertently make the situation worse.

A bad situation is about to get much worse.  Two bills pending before the California Legislature, AB 764 and SB 94, will apply criminal penalties and fines to real estate brokers and attorneys who charge advance fees or take retainer fees to handle loan modifications.  The primary basis for this approach appears to be the continuing assumption that homeowners can get these services for free from the lenders themselves, or from HUD authorized nonprofit loan counselors.  Any broker who wishes to charge for these services must first obtain approval from the Real Estate Commissioner and comply with the new provisions of the law.   Violation of these provisions by an attorney would constitute grounds for disciplinary action.  Unfortuately, this legislation — like many other recent regulatory actions — attacks the wrong problem.

On the surface, this consumer-protection legislation appears to address a serious problem:  the rash of scam artists seeking to profit from the thousands of homeowners facing hardship and possible foreclosure.  It is too early to predict whether these bills will pass, but the trend is clear.  Authorities are clamping down on the widespread abuses and scams that have plagued distressed homeowners for the past couple of years.  One company recently shut down by the FTC in Southern California had 400 employees, seven attorneys, and claimed a 98% success rate at “modifying” loans.  In one of these, the lender increased the mortgage payment by over $300 per month — even though the homeowner was current on their payments!  The “loan mod” company charged the homeowner $3,600 for this “modification.”  This was not an isolated case — approximately 60% of all “loan mods” approved by lenders in the first three Quarters of 2008 resulted in either no change or an increase in the borrower’s mortgage payments!  To no one’s surprise, a majority of these “modifications” failed and the properties went back into foreclosure, prompting renewed efforts by the Federal government to offer incentives to lenders to actually lower monthly payments.  (These Guidelines were released on March 4, 2009).

Nonetheless, thousands of homeowners, facing foreclosure and fearful of losing their homes, were scammed into paying money to unscrupulous individuals and companies who promised to “stop foreclosure” and “save your home.”  Responding to the problem, the California Department of Real Estate (DRE) issued a “Consumer Alert” and established a program which would allow real estate brokers to submit their Advanced Fee Agreements for review and the opportunity to be listed on the DRE web site if the DRE issued a “no objection” letter.  The DRE now lists hundreds of brokers on their web site who have been “approved” to charge advanced fees.  The DRE also list over 240 individuals and companies against whom the DRE has filed a “Desist & Refrain” Order and/or Accusation for loan modification activities.

On June 1, 2009, the California Attorney General issued a press release directing anyone who acted as a “foreclosure consultant” to register with his office and post a $100,000 bond by July 1, 2009.  The press release also lists several enforcement actions taken by the AG in relation to prosecuting loan modification scam artists.

Earlier, in February, 2009, the California State Bar had released an “Ethics Alert” that contained a fairly comprehensive discussion of the background leading to the current foreclosure crisis, and warned that attorneys who offered their names to non-attorney companies in order to allow those companies to collect advance fees were in violation of the Rules of Professional Conduct, which prohibit licensed attorneys from assisting non-attorneys in the practice of law, and prohibit attorneys from splitting fees with non-attorneys.  Also, the Ethics Alert reminded attorneys that it was a violation to file lawsuits to delay a foreclosure sale without good cause.

These and similar measures are designed to protect consumers and homeowners, ostensibly from the potential scams of companies seeking to profit from the chaos in the housing crisis.  However, as distasteful and outrageous as these practices may be, they are not the real problem.  A blanket attack on real estate agents and attorneys will invariably sweep up many professionals who, by virtue of their expertise and training, are in the best position to actually provide much-needed assistance for these distressed homeowners.  At the same time, this regulatory approach does nothing to make the task easier for the homeowner to handle the task themselves — the legislation directs them to go to a local HUD office or to their website at  www.HUD.gov to get a list of approved nonprofit housing counseling agencies.

The real problem is two-fold.  First, the process whereby these loans were securitized, fractionalized, sold, and resold means that in any given instance, the “lender” is merely a loan servicer for an investor two, three or four times removed from the original institution that originally approved the loan.  Each investor has specific restrictions and requirements beyond which the “lender” may not modify the terms of the loan.  There is no ability to negotiate directly with the investor, and the process for reviewing each application in light of these requirements takes anywhere from a month to 90 days or more.  The second aspect of the real problem is there is no real incentive to provide meaningful relief in the form of principal reduction, or otherwise offer modifications that will make a difference.  “Loan Mods” that simply shift the debt load to the back end of the loan, or offer insignificant adjustments (i.e., a 27-cent monthly reduction), as an alternative to foreclosure, really do not accomplish anything.  Forcing a distressed homeowner who has suffered a sudden loss in wages or other genuine hardship to endure three to four months of back-and-forth with an unnamed and undisclosed “investor” just to receive an unacceptable or meaningless proposal is bad enough.  Limiting — if not eliminating — their range of options to seek competent assistance merely adds insult to injury.  Making it virtually impossible for competent professionals to charge for legitimate services will only force them to refuse to participate, and do little to address the real problems.

There is no question but that there have been outrageous abuses by scam artists seeking to profit from the crisis.  Existing regulations govern the conduct of licensed real estate and legal professionals, and if properly applied and enforced, would address most of these types of problems.  What is needed even more is meaningful and effective regulations to allow lenders the ability to modify existing loans without the hidden restrictions imposed by silent investors lurking in the background.   Focus on the real problem — don’t attack the lifeguards and ignore the sharks!

According to an article that appeared in CNNMoney on Monday, May 18, lenders are overwhelmed by a flood of applications; mortgage investors are threatening to sue loan servicers for modifying loans, and unemployment is the newest threat to stabilizing the housing market.  This article comes on the heels of an announcement on Friday, May 15 by the Obama administration, announcing a new, standardized process and incentives for short sales and “deed-in-lieu” transfers of ownership.   The newest initiative is aimed at homeowners who cannot get loan modifications. These newest actions follow by two weeks the Government’s announcement that it would provide incentives to lenders holding second liens to reduce interest rates and/or release second mortgages.

Anyone involved in the loan mod process would have to acknowledge that the entire process is bogged down.  CNNMoney noted that even though it has been three months (to the day) since President Obama announced the Housing Affordability and Stability Plan (February 18, 2009), and Guidelines were issued on March 4, many (if not most) loan servicers have been slow to get up to speed to respond to the requests.  Borrowers frustrated by the lack of clear guidance and inconsistent advice are tempted by robo-call operations offering to “help” homeowners for hefty fees.  Ironically, it turns out that investor contracts arising from the securitization and sale of the loans, which was part of the problem in the first place, are restricting which loans can be modified and how.   Congress is working on a bill to provide a “safe harbor” to allow loan servicers to use the Federal mortgage relief programs, but some investor groups are lobbying hard against passage.  It is no secret that many loan servicers are using the “investor contracts” as excuses not to make prompt and effective modifications.  Unfortunately, the borrower has no way of knowing whether or not the excuse is valid.  One gets the same feeling one gets when the car salesman returns from the back room to report the General Manager’s “last, best and final” offer, but you never even see the guy behind the curtain.

Compounding the problem and undercutting efforts to stabilize the mortgage crisis, many lenders have yet to sign up for the Federal program.  According to CNNMOney, 14 of the mortgage service companies, including Bank of America, Citgroup, J.P.Morgan Chase & Co., and Wells Fargo.  Others claim to be implementing their own versions, and still others are evaluating the program.  At the application level, each lender and loan servicer appears to have their own processing requirements.  Some permit the borrower to send the required documentation electronically, while others insist the documents be sent by fax.  One loan agent told me their fax room was a complete mess, with different applications getting mixed up with others like a crazy game of 52-card pickup.  Another loan agent told me they had no way to confirm receipt of the electronic transmission of the application documents.  Still another e-mailed me within 24 hours to confirm receipt, followed up 5 days later with a request for a missing piece of information, and provided an estimated time of review and affirmed that the foreclosure status was being suspended pending review of the loan mod application.  Simply stated, there is no uniformity or standarization.

As I’ve reported before, the fact that some of the lenders and loan servicers are only now just beginning to implement the Guidelines first released on March 4, and others are still “evaluating” the program, calls into serious question any claims or reports of successful loan modifications.  Sixty percent (60%) of all reported “loan mods” approved in the first three Quarters of 2008 resulted in mortgage payments that were the same or higher than prior to the modification.   I saw one “approved” loan modification that reduced the monthly payment by 27 cents!  And that lender insisted the borrower was foolish to reject it!  This type of chaos and confusion will only serve to further destabilize the process; create additional opportunities for fraud; and worst of all, erode any sense of confidence that the Federal program might otherwise have a chance to work.

In addition to the impact of rising unemployment cited by the CNNMoney article, there is another growing threat to the Federal effort to stabilize the situation — credit card debt.  Broke, facing unemployment, and no longer able to tap their home equity for relatively inexpensive funds to make up the difference, many homeowners have tapped the most costly source of revenue remaining — their credit cards.  Unfortunately, the card companies, who reset the loan rates faster than you can say “charge it,” have started charging cardholders the highest possible default rates of 29.99%.  Behind the wave of home foreclosures working their way through the so-called “trial periods” and voluntary moratoriums is a second wave of crushing credit card debt.

Sadly, the situation is bound to get worse before it gets better.  Unless and until the loan servicers get clearance from the investors, or simply clear directions from their managment, and free up the backlog of applications, the confusion and frustrations will continue to mount.  One problem is that no one knows what will work, and therefore everything is approached with the same level of risk aversion.  It would be a great service if the U.S. Department of the Treasury could simply select a statistically significant cross-section of different types of loans, fund the modificaion, and see what would really work to increase the probability of success.  Hindsight, of course, will teach us all many lessons.  The question is whether we can wait long enough.

On April 28, the Obama Administration announced additional details on the Second Lien Program, in an effort to provide help for homeowners with both a First and Second Mortgage on their property.  It is estimated that up to 50 percent of at-risk mortgages have second liens.  (Of the number of people who have contacted me for advice or assistance, the number with Second Liens is more like 98%).

The stated goals of the Second Lien Program is to provide relief for up to 1 to 1.5 million homeowners, to reduce second mortgage payments, provide pay-for-success incentives to servicers, investors and borrowers, and develop a payment schedule to extinguish second mortgages altogether.  The Second Lien Program provides that a second lien or mortgage will automatically be modified when a First Lien is modified.  For details, go directly to the Second Lien Program Fact Sheet.

For many homeowners, this will be welcome news, if the lenders cooperate.  The Obama Administration recognizes that even if the lender holding the First Mortgage works out a modification, many homeowners continue to face the prospect of foreclosure because they cannot keep up with the Second.  For qualifying loans, the Program proposes to

lower the interest rate on amortized loans down to 1 percent, and for interest-only loans, down to 2 percent, both for an interim period of five years.  Participating servicers will be required to forbear principal on the Second lien in the same proportion as any principal forbearance on the First lien.  There is an option for extinguishing principal under a published schedule.  Various incentives for lenders, servicers and investors are included.

Many individuals who initially contacted their lenders when the Hope for Homeowners (HFH) program was announced in 2008 and received less than satisfactory results will be pleased to know that the Obama Administration has also announced a new plan to include the HFH in the Making home Affordable program.  Even if you were turned down or otherwise dissatisfied with an initial attempt to modify your mortgage, you should be aware that the rules changed on March 4 when the Obama Administration released new Guidelines, and again on April 28 with the announcement of the Second Lien Program.

Will the Real Federal Mortgage Relief program please stand up?

Two stories in today’s financial media tell two different stories:  “Banks Ramp Up Foreclosures,” and “Up to $9.9 Billion to Modify Mortgages.”  (WSJ).  The first article details how many lenders have simply abandoned their voluntary moratorium on foreclosures and have gone ahead where borrower were delinquent.  The second details how the Administration has reached agreements with six lenders, including Chase Home Finance (J.P. Morgan Chase & Co.); Wells Fargo & Co.; GMAC Mortgage Inc.; CitiMortgage (Citi Group); Select Portfolio Servicing; and Saxon Mortgage Services, Inc., to provide up to $9.9 Billion in

mortgage modification assistance in line with the Guidelines released on March 4, 2009.  As noted in the article, many of these lenders have been taking applications and hopefully will now be able to process them.  According to the Guidelines, any loan modification agreement reached under the new terms must go through a 90-day trial period before the lender will be entitled to the incentive funding being made available.  The article noted that the Administration hopes to work out similar agreements with other lenders.  Noticeably absent from this first list of lenders is Countrywide.

So, where does this leave the situation?  If some banks are ramping up foreclosure sales at the same time as others are getting ready to receive large amounts of federal funding to modify or even refinance their loans, it won’t surprise me to see homeowners receiving two very different notices in the mail, given the propensity for the lending institutions to have a right hand and a left hand that do not know what the other is doing.  In my recent efforts to assist some homeowners with loan modifications, I have not heard much to give me much confidence that the process will be under control anytime soon.

As I have stated before, the most important step for a homeowner to take is to contact their lender if they feel they need to be considered for a loan modification or refinance.  Eligibility criteria is available at www.financialstability.gov, but I continue to urge any homeowner who is struggling to make ends meet to see if their lender will process an application, even if the lender will not be eligible for incentives under the Administration’s program.  Be prepared to submit a letter explaining your hardship, and documentation of your income and expenses, including W-2s, tax returns, pay stubs, bank statements, etc.

A quick word about the many so-called “loan mod specialists” claiming they will save you from foreclosure — for a fee.  The California Department of Real Estate and the California State Bar have issued ethics alerts concerning the ground rules for brokers and lawyers to charge fees for assisting homeowners.  Many services that use robot calling devices claim to be working for law firms or claim an association with an attorney in order to justify charging fees in advance.  Many of these companies are operating illegally and in violation of the Rules of Professional Conduct that govern the practice of law in California.  For a detailed but concise statement of the applicable rules, see the State Bar’s release at http://calbar.ca.gov/calbar/pdfs/ethics/Ethics-Alert-Foreclosure.pdf.  As a homeowner, you are free to contact your lender on your own.  If you desire professional assistance, contact a licensed Real Estate Broker that has been cleared and listed by the State DRE, or contact a licensed attorney directly.

A report released on April 3 concludes the obvious:  a study shows that loan modifications that reduced monthly payments had a lower rate of redefaults.  The good news is that the Office of the Comptroller of the Currency and the Office of Thrift Supervision directed the banks and thrifts that provide data for the Mortgage Metrics report to assess their criteria for loan modifications woudl result in affordable and sustainable modifications.  The OCC and OTC included loan modifications already made in 2008 in their direction.

The study confirmed what had been widely reported earlier — a high percentage of borrowers with approved loan modifications had fallen behind or defauted.  What had not been reported was that almost 60% of the loan modifications approved in 2008 resulted in either no change to the borrower’s monthly payments, or an actual increase.  Reasons for this included the fact that in many cases, the lender merely froze the rate on an adjustable loan (ARM), and in some cases recapitalized the past-due amounts, resulting in a higher monthly payment.  These modifications achieved the goal of avoiding foreclosure, but not for sustained periods.  According to the report, loan servicers said their flexibility to reduce payments was constrained by servicing agreements with government-sponsored entities and private investors that restricted the type and amount of loan modification permitted.  Recent changes in both government and private servicing standards should provide greater flexibility to loan servicers.

The report covered mortgages serviced by nine large banks and four thrifts that constitute two-thirds of all outstanding mortgages in the United States.  One interesting revelation was that the biggest percentage jump in serious delinquencies was in prime mortgages, which account for nearly two-thirds of all mortgages serviced by the reporting institutions.  Delinquencies in this lowest loan risk category more than doubled in the fourth quarter of 2008!  The subprime mortgage category continued to have the highest level of delinquencies.  Possible reasons for the re-default rates included the worsening economy, excessive borrower leverage, or poor initial underwriting.

Real estate investors, business entrepreneurs and homeowners recognize that the most critical element of a sustainable transaction is cash flow.  Modifying loan servicing standards to allow lenders to make loan modifications that work with a borrower’s cash flow will go a long way to avoid redefaults and foreclosures.  The report provides strong support for the Administration’s loan modification program, which is primarily based on lowering monthly payments in order to achieve sustainable modifications.  Since the OCC/OTS report reflects servicers for about two-thirds of the nation’s outstanding mortgages, we can only hope the message gets out quickly!

Important:  This brief summary is provided as a quick guide only; a link to the official details and an online eligibility assessment tool provided by the U.S. Dept. of the Treasury is provided below.

UPDATE:  On March 5, the House passed the “cramdown” legislation, which would allow Bankruptcy Judges to modify the mortgage on a owner-occupied home, provided the homeowner first made a good faith effort to complete a loan modification with the lender.  The measure now goes to the Senate where it is expected to encounter stiff opposition from lenders.  See Washington Post article.

As promised, the U.S. Dept. of the Treasury released the Homeowner Affordability and Stability Plan (HASP) Guidelines on March 4, 2009, to take effect immediately.  There are two basic components of the Making Home Affordable plan:  refinancing and modification.  Most of this discussion will focus on the Home Affordable Modification Program, but first a quick comment about eligibility for the refinance component.

To be eligible for the Home Affordable Refinance program, the property must be owner-occupied, the borrower must establish they have income to support the new mortgage debt, and the amount of the first mortgage cannot exceed 105% of the current market value of the property.  Junior lienholders must agree to subordinate, borrowers may not take cash out, and borrowers who are delinquent will not qualify.  Details for the new refinance options for existing Fannie Mae Loans are set forth in FannieMae Announcement 09-04, released March 4, 2009.

To be eligible for the Home Affordable Modification program (HMP), the property must be owner-occupied, not vacant or abandoned, the current mortgage payment must be more than 31% of the borrower’s gross monthly income, and the borrower must have experienced a significant change in income or expenses to the point where the current payment is no longer affordable.  The borrower need not be delinquent, but they must be at risk of “imminent default.”  Jumbo conforming loans up to $729,750 are eligible for the HMP.  Participating servicers are required to follow specific steps in the Guidelines to attempt to reduce the monthly mortgage payment to as close to 31% Debt-to-Income (DTI) ratio as possible.

The modification process, referred to as a “Waterfall” process, starts with a determination of Monthly Gross Income, then validation of total First Mortgage Debt — monthly PITIA.  Servicers are then required to capitalize all arrearages, and target achieving a DTI of 31% by incrementally reducing interest rates down to a minimum of 2% for a five-year period.  (After that, the rate will increase by no more than 1% per year until it reaches the Interest Rate Cap.)  The next stage in the “Waterfall” process is to extend the term up to 40 years, starting with the date of the modification.  If this is insufficient to achieve a DTI of 31%, the servicer is expected to forebear principal, to be due upon maturity date, sale of the property, or upon payoff of the interest-bearing balance.  No interest will accrue on the forbearance amount.  Under no circumstances may the modified balance due be lower than the current market value of the property.

No principal reductions are required under the HMP, but lenders may, at their option, elect to reduce principal if necessary to achieve a 31% DTI.  The program will reimburse servicers for a portion of the cost of a principal reduction.  Each borrower will undergo a 90-day trial period.  No incentives may be paid until the 90-day trial period has been completed.  Lenders may not charge the borrower any fees or charges for this modification process.  Junior lien holders will be required to subordinate to the modified loan, and the HMP provides an incentive payment up to $1,000 to pay off junior lien holders, and an additional $500 incentive payment for efforts to extinguish  second liens.

If, after going through the process, it is determined that modification is not an option, the Guidelines suggest that all loss mitigation options be considered, including any possible refinancing options available outside of the program, and if homeownership retention is not possible, program counselors should discuss short sales and deeds in lieu of foreclosure as ways to help the borrower transition to more affordable housing.  Incentives for participating services are available for alternative approaches, and borrowers may be eligible for relocation expenses to effectuate short sales and deeds-in-lieu of foreclosure.  The ultimate objective is to minimize the impact of vacant and abandoned properties on local communities.

Foreclosure actions will be suspended during the process.  Therefore, it is important that any person facing foreclosure initiate all steps necessary to start the process immediately.  Persons in this situation are advised to contact their lender, and to call the Homeowner’s HOPE Hotline at 888-995-HOPE.  To find out if you may be eligible for a refinance or loan modification under the Program, you can go online determine whether or not you are eligible.  This self-assessment tool is made available by the U.S. Dept. of the Treasury at www.financialstability.gov.

Get ready for a perfect storm — a Category 5 foreclosure tsunami.  The first wave was launched on February 17 when FannieMae announced an extension of the temporary halt to foreclosure sales (Lender Letter) to March 6, 2009.  The second wave came on February 18 as President Obama announced the Homeowner Affordability and Stability Plan (HASP).  This Plan included the start of the third wave of this storm — the announcement that Guidelines will be released on March 4, 2009.  When these three events collide on or around March 4 - 6, hundreds of thousands of homeowners, investors and tenants are going to wake up to find themselves adrift in a stormy sea of chaos with no life preserver.

Unless the Federal government comes up with a miracle when it releases the much-anticipated Guidelines on March 4, we can anticipate a sharp increase in the number of foreclosures that will be filed and/or processed.  Moreover, the sheer number of foreclosure actions currently pending in the nations’ State courts will have to be processed off the books.  The same day as President Obama announced his plans for mortgage relief, the WSJ carried an article about a Judge in Lee County, Florida, running a “rocket docket” to clear the backlog of pending foreclosure actions.  He only had two questions for the homeowners:  Are you current?  Do you still live there?  For those who answered “No” to the first and “Yes” to the second, he gave them 60 days to work out a deal or move out.  President Obama, in his Feb 18 speech, pretty much left only one option for those who were not current on their payments — Bankruptcy court.  Although lenders generally would like to avoid this option, borrowers have little hope that the results will be any more favorable.  There is very little sympathy for the borrowers in these situations, and therefore very little political will to launch a rescue effort.

Adding to the chaos of this bleak forecast is the fact that hundreds of thousands of borrowers are being swindled by loan modification scams promising to “stop foreclosure now” and “save your home.”  Although these so-called “loan mod experts” have been around for years, their business took off in the past couple of years as the Federal government put pressure on lenders to voluntarily work out new terms in order to keep people in their homes.  Unfortunately, approximately 60% of the loan modifications that were worked out have gone back into foreclosure.  The blame seems to fall evenly between the lenders’ meager concessions and the economy’s continuing decline.   It doesn’t matter what new terms you agreed to in January if you got laid off in February!

Unless the HASP Guidelines includes a miracle and not just a placebo of unrealistic conditions, and unless Fannie Mae and the lenders extend the moratorium on foreclosures, we can expect foreclosure hell to break loose in early March.  Sadly, the impact will be devastating on families, neighborhoods and communities across the country that are already suffering from the blight of foreclosures.  The Obama Administration must recognize that this situation is akin to a Category 5 economic storm that will rage across the entire country, and must respond accordingly.  Failure to do so will make the Bush Administration’s response to Katrina seem benign in comparison.