Subprime: “What’s the best way forward?”
[Related to but independent of yesterday’s post .]
Yesterday’s post explored the lender’s first critical and unvoiced question: “why are you in trouble?”, and emphasized how important it is to have a convincing and positive answer to the question, right on the tip of your tongue.
I’ve been making the monthly payments
However, even after this question is addressed, a second one immediately looms:
“Sir, I have a question.”
“What’s the best way forward?”
Turn here.
Why you’re in trouble is the past, and past is prolog, but the lender really wants to know what’s the best that can be obtained from the current mess. Whether or not the lender makes any mention of these, the lender is casting about for one of several possible outcomes. Underneath the lender’s anxiety are two premises that you want to be true, and to convince the loan servicer are true:
- Doing something is better than doing nothing.
- If you take a chance on me, I will come through for you.
Before you can get to them, however, it’s critical for the borrower to get past the invisible but powerful non-outcome that happens all too often:
Foreclose and hold the property in inventory, hoping things will get better. This isn’t always rational – in fact, it’s usually irrational – but it’s human nature. Many is the careerist whose philosophy can be summarized as, No bad news reported on my watch.
“we only report all the bad news that’s fit to print, Chet.”
Key in that sentence is the magic word ‘reported.’ A lender who forecloses may not be making the smartest decision for his company, but he’s making the safest one. Just as, in a previous age, ‘nobody ever got fired buying IBM,’ few loan servicers get fired for being overly zealous in their foreclosures.
Your problem is that a mindless foreclosure wipes you out. So, first and foremost, you want to convince your loan servicer that some form of action is a better result for the company, and for her personally, than foreclosure. This means that the lender will have to choose one of the following options:
1. Sell the property now and get more than the loan back. Just because you can’t make the loan payments doesn’t mean that the lender must take a loss. You may be over your head.
No, really, I can make those payments!
You may have stretched to get into the house in the first place. Something bad may have happened to your personal finances from which you’re not going to be able to recover.
For the borrower, a house whose value is greater than the loan is a bad-news/ good-news story. It’s bad news because the lender’s almost certainly going to force the house to be sold. It’s good news, however, because if the property can be sold for more than the debt, the current owner has equity. So the homeowner will have to move, but will get something back from his or her down payment.
Until a year ago, this was the bailout for many an overextended borrower – rising prices lifted resale values, and when people got stuck, they sold. Now, with the newspapers full of headlines about weak markets, and the inventory of unsold houses high and apparently still climbing, most lenders and loan servicers are prepared for the likelihood that they can’t simply flip the house to a new buyer and get out whole.
The sort of sign that doesn’t inspire confidence
2. Sell the property now for less than the loan balance. Foreclosure, technically, is an auction sale, where anybody can bid. The lender is not obligated to bid the full amount of its loan – in fact, the lender isn’t obligated to bid anything. Sometimes the lender wants never to take title at all, so when the property goes to foreclosure, a bid below the current indebtedness wins.
When that happens, the total amount is paid to the lender, and the remaining loan balance is cleared from the property. You the borrower may still owe the shortfall – you probably do, unless the loan is non-recourse, which is common in income-producing property and rare in single-family mortgages – but the property is gone and the mortgage with it.
How do lenders know what they will get on foreclosure? A mixture of comparable recent sales – particularly in markets with many properties in default – and appraisals.
In other words, they don’t know.
“George doesn’t know why he’s paying you $1 million a game.”
The weaker your local resale market, the more uncertainty and cost attaches to foreclosure. That’s better for you as a borrower, because it makes more attractive the ease and certainty of dealing with you – if, that is, you’ve been a good borrower and have a plausible story why you’re in trouble now.
3. Refinance into a cheaper or lower-payment loan. Sometimes it’s not the loan principal that gets you, it’s the interest, the fees, the penalties, the arrearage – in short, the whole paraphernalia of indebtedness.
When it comes to these add-ons, lenders are like a cross between a school librarian and an irate airline passenger.
Conan da librarian wants to know vy you didn’t return your bookz
The librarian charges library book fines not to make money, but to get you to return the book. When the fines have piled up to the point where they’re close to the book’s price, the penalties have failed. Now the librarian’s just interested in getting the book back.
The airline passenger is irate when the plane is late, or they run out of snack boxes, or the movie channels don’t work – in short, when the complaints relate to the quality of service, not the certainty of arrival. Tell that same passenger that it’s a blizzard in
In the cases of both the librarian and the airline passenger, they have an aggressive attitude if they think they’re safe, but once each of them realizes there’s a downside, something they care about a great deal more, their whole attitude changes.
Just get us out of here
The same thing is true of lenders and late fees. If they think the fees are motivating you, or are collectible, well then they pile on imperiously. But let them start worrying about the repayment of principal, and the same people are willing to waive the excesses just to reduce the amount of writedown they have to take.
Don’t go there
In other posts, we’ve seen that a major component of the subprime mess is the phenomenon of rate reset, and the resulting spike in payment obligations. Because a rate reset that a borrower cannot pay is illusory income, AHI’s proposed national subprime legislation in effect proposes waiving that uncollectible premium, and to make it possible for lenders to do this in bulk, we’ve structured it as national legislation.
4. Permanently reduce your payments on this loan. This is a variant of the preceding one. If your problem is that you can’t pay the current rate, and the current rate is higher than the market alternative, a lender who lowers your payments may actually be getting a higher collection than any other option available to it.
For this option to be the lender’s best choice, however, requires the lender to believe three things:
- You’re paying as much as you can now.
- You’re not likely to be able to pay a lot more in the future.
- No foreclosure alternative is better.
I believe at least three things
See how there’s a relationship between the borrower’s behavior, which is specific to each loan, and the market alternative, which is influenced by macro factors?
5. Temporarily reduce your payments on this loan. This is the easiest one to grant, and therefore it’s the one you should ask for last. It’s very logical for the lender:
If you’re doing all you can
And the reason you can’t do more is something temporary
And you can be persuasive that you will do more in the future
And foreclosure’s unappetizing,
If so, then it’s relatively straightforward to secure a temporary loan modification.
Lenders also get a less-obvious benefit from these modifications — it shifts the loan from ‘non-performing’ to ‘performing’ status (even at a reduced rate) and thus helps lender financial and stock market reporting.
Conclusion: keep your eyes on the prize. Although a lender is not your friend, neither is the lender your enemy. Loan servicers want to do something that’s good for the company, safe for themselves personally, and likely to work. They make these judgments based largely on statements you make and evidence you provide to support those statements.
They care about the answers to two questions:
Why are you in trouble? Whatever explanation you give, it had better be the truth.
What’s the best way forward? Your goal is to demonstrate that foreclosure, although administratively reliable, is a very risky financial path, whereas modifying with you, however it may sting, is reliable.
Performing loans preferred
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