The ‘Ins and ‘Outs of Loan Modifications

The ‘Ins and ‘Outs of Loan Modifications

by Peter L. Mosca

[Note: To follow is an excerpt of an interview with Bob Diamond, a practicing real estate attorney, real estate developer, and published author of three books on foreclosure investing. To listen to the show archive or download an MP3, go to]

Mosca: There are about 9 million homeowners out there many of whom are under water, meaning they owe more on their homes then the property is currently worth. Most will be seeking a loan modification this year. What, if anything, is new with today's loan modification process?

Diamond: It is one of the most quickly changing areas in real estate. It is a complete moving target. We estimate that a third of the people in America are upside down. Can you imagine a third of the people owe more on their mortgage then their house is worth, and those mortgages are going to have to be modified. People are not going to pay $300,000 for a mortgage when they have a house worth $100,000. It doesn't make any sense to do that, and often times it makes more sense to turn the keys over to the bank and then go get a different house. That completely helps the leverage you have with the bank because they know that is what you can do -- that you can walk away from your house or property if you have to. The other thing new, and especially appropriate to your program, is that you now can get banks to modify investment property loans, commercial property loans, multi-unit, and single-family. Most importantly, many banks will modify them even if you're not yet in default, which is a brand new position that a couple months ago were all but impossible.

Mosca: Are banks trying to be more proactive rather than reactive?

Diamond: They have to. The only reason they are doing this is they are pushed against a wall. The banks took the TARP money and put it in their accounts and left it there. Banks have something called a liquidity ratio and a capital ratio, essentially they have to have their own capital and they can then lend multiples of that. Their capital had gotten depleted, so they needed to sure up their capital, meaning put money in their accounts, that way they could lend more money. If the bank's capital drops down too low, they actually have to sell off loans to other banks to raise cash. Banks don't want to do that, so what they did with last year's TARP funds is they put it in their account. That is why they did not lend any of the money out. They could say, "Well we will just hang on to those TARP funds and hopefully things will turn around. The markets will get better." They are sort of like some homeowners in foreclosure where they often have a mentality that somehow this awful thing won't happen. The banks are institutionally in denial.

Mosca: [A caller named Michael from New Jersey] Are banks willing to reduce the principal on these properties?

Diamond: That is a great question, and you are straight on. A loan modification is quite simply changing the terms of the loan. From a homeowner or property owner's perspective it makes it easier to pay. From the bank's perspective, a loan modification keeps the bank from going into default and causing an even bigger loss. Typically, banks recover about 65% of the value of the property when they foreclose. According to the studies that they have done banks lose about 35% of the value through all the costs associated to the foreclosure, everything from the trustee, to the missed payments, to the missed interest, to the charges they paid to the property management company, to the charges they paid to a realtor, loss of interest over the months they have the property. Banks want to stop a default, but the tools they can use are many. They can reduce the interest rate, which would reduce the monthly payment. They could stretch out the term of the payment; from say a 30-year mortgage to a 40-year mortgage.

Mosca: What about the principal?

Diamond: They could also reduce the principal. The problem from the bank's perspective of reducing the principal is that there is no hope for the future. Think about it. Let's say that the bank reduces the interest rate from 8% to 4%, which would be a typical thing we could achieve in loan modification. If you decide three years later that you're going to move and sell your house and the market has improved enough that you can actually get out from under your house, which again is fairly likely that over time housing values will come up and the bank can get repaid in full. If they've only reduced the interest rate than their loss, the money that they don't collect, is just the lower interest rate over three or four years, but if they lower the principal balance then even if you sell the property in three or four years you might make a big profit as the homeowner but the bank doesn't. Reducing the principal balance is the thing that they resist the most.

Michael [the phone caller from New Jersey]: Why not have the bank share in the profit when you sell it?

Diamond: They're not that creative. I agree that would be a good solution, but I have not seen them get that creative. Banks are moderately creative. I negotiate both residential loan modifications and commercial. Commercial you can do a lot more because you have people with more leeway that you are talking to at the bank. You have a loan officer who's going to get a black mark on his personal record if that loan does not get straightened out. You have someone who is responsible for loan initiation and if that person is still there, they will get a black mark on their record. So, they will be more creative and they will pay more attention to it. For residential, they have little boxes they can put things in that start off with reduce the interest rate, stretch out the term, take any interest and penalties and fold them into the loan, which may increase the principal balance or tag them on to the end. I don't think they have a box for a shared appreciation loan. I agree with you. It's a great idea. I just don't know if they are going to be that creative.

Mosca: I wanted to get your opinion on the bankruptcy bill that's still sitting there on Capital Hill. Do you think it's going to go away?

Diamond: I understand why the banks are fighting it tooth and nail but I believe it's going to pass. Here's what they are proposing: if you have a property with a $300,000 loan and now it's only worth $200,000, in most types of bankruptcies, like commercial bankruptcies where you might have a store that has inventory or commercial bankruptcies where you might have a factory, if the collateral securing the loan is worth less than the loan, one of the things you can do is reduce the amount of the loan down to the value of the collateral and you bifurcate the loan -- you split it. You get an unsecured portion, which is like credit card debt and you get a secured portion, which is actually secured. The legal theory behind it is that you are only secured to the extent that the collateral is worth something. So, with an asset worth $200,000 and debt of $300,000, you can't possibly be secured to $300,000 because if the lender foreclosed they would only get $200,000 at the most. The idea behind bankruptcy is the lenders get what they were entitled to if they were able to foreclose but the person or company in bankruptcy can spread those payments over time -- or do something else. The way 90% of all bankruptcies work is that you can bifurcate like that. The exception to that is consumer mortgages. In a consumer mortgage, up until now, you have not been able to bifurcate or split mortgages. So, if for example you purchased a property for say $500,000 in San Francisco and now the property has dropped to a $300,000, you can't go into bankruptcy and say to the judge the house is only worth $300,000, so I want the mortgage principal balance to be reduced to $300,000. The proposal is to make that bankruptcy like all the other bankruptcy areas where your security is only worth whatever it is worth and that's the amount of your secured mortgage.

Mosca: We stress on this program that when it comes to real estate investing, when it comes to the largest investment that most people make in their lifetime, whether it's a long-term investment in the home or an investment in real estate for short or long term gain, the bottom line is you should have a team of professionals with expertise in these areas. It's not that people are not intelligent or lack the discipline, the bottom line is these are tricky procedures, tricky processes, comprehensive transactions and there is no way the average person is going to know all the ins and outs like a professional like you with the expertise. Your thoughts?

Diamond: It's impossible. Let me put it into two contexts. One is negotiating for a car and the second is negotiating for a property. Could you ever really negotiate for a property if you didn't have any comparables? If you didn't have any idea about what other properties were going for in the neighborhood, how could you decide what the right price was to pay? If you're negotiating a loan modification you need to know what's possible or what other people are getting -- the comparables of loan modification. The banks are sophisticated negotiators. They want to get the most money they can out of you. If you think you're going to go in there without any knowledge or sophistication and negotiate a good deal, you're not. You definitely want to get a professional that knows what you should be getting because otherwise you're just not going to do well.

Mosca: Are there guarantees in the loan modification process?

Diamond: All you can guarantee, like we do, is that we will be diligent, we'll work hard, be honest, and will give you the truth. We can't guarantee a specific result and the reason is we don't control the result. We can do a good job but ultimately there are two parties negotiating -- the bank and us. The bank can change a policy, they can decide to do something more generous or less generous, they can decide to modify some types of loans and not others, and often there is an investor standing behind a bank that's giving the thumbs up or the thumbs down. You can't guarantee a result. Anybody who does guarantee a result isn't being truthful with you.

Mosca: So, if you are being approached and someone says to you, "I can guarantee you this" should that be a red flag?

Diamond: Absolutely. Someone can give you a range; we will give a range to people based on the bank and similar situations. Another red flag is someone who wants to take a large amount of money up front. First of all, they lose all of their incentive to do anything. Number two, they don't need a large amount of money up front. To evaluate a case, look over and figure out what you can do, shouldn't be an expensive item. At most, the cost should be $1,000 at the absolute maximum -- $500 is a more reasonable number. The other question is the qualifications of the person doing the negotiating. A lot of the people in this business are the people who are in the ‘business of the week' club. They see something that they think is easy money, they can just not do any work but get people to pay them, and then they just market the heck out of it.

Mosca: What is the typical cost of a loan modification?

Diamond: A typical cost and the normal range that you would expect to pay would be somewhere in the range of two to three mortgage payments, assuming you don't have a $200 month mortgage because then I don't know why you would need the modification anyway. Since this is something you are paying on for probably the next five to seven years, if you get a better deal by hiring a professional to negotiate for you, you are going to save many times the money that you've spent. I know it is tempting for people who want to go and negotiate themselves, but it really is not a wise choice. Remember, this is financial war. We need to go in with all of the weapons. You are going with a cardboard sword when you go in by yourself.

Mosca: Do homeowners need to sign over their title to their home?

Diamond: NO! If they give you a power of attorney to sign or a deed to sign then throw them out of your house. When people do that, they are absolutely committing fraud. There is no reason to ever sign a deed over to someone unless you are selling your house and you're going to settlement and doing a typical procedure. Signing a deed over to someone is not part of a loan transaction and it is not part of anything that would have to do with loan modification ever. That is a scam.

Mosca: One other red flag has to do with escrow accounts. Some people are told to put money in it, what's your take on that?

Diamond: I personally like escrow accounts. You should have a little extra, a little cushion in there, maybe a month or two and it saves you from having to worry about forgetting to place insurance on the property, forgetting to pay the bill, not getting the bill and not paying it, and the same thing with taxes. If you don't pay your taxes, you can lose your house. It really doesn't cost you any more to escrow for taxes and insurance, so I am actually a fan of it.

Mosca: What is your golden nugget for the day?

Diamond: My mantra in real estate is to make sure you negotiate a really good deal up front because that is where your money is made. In my experience in real estate, and I've done about $100 million worth of transactions in one capacity or the other, either as the investor or as the attorney, the buyer, the seller, the one common theme when you make money is make a great deal up front. Right now in this foreclosure crisis, there are fantastic deals out there. I've never seen a buying opportunity like this. The best deals are in the markets that shot up like a rocket and are now crashing back to Earth. There are fantastic commercial deals that are coming up and are going to continue to come up for the next two years. There's a lot going on between going into next week with collateralized mortgage backed securities that are going to lead to incredible deals in commercial properties over the next two years.

Mosca: That's a great lead-in for next week Bob. We look forward to having you discuss that particular aspect of what is happening in the commercial marketplace next week on Income Property Investment Talk.

Published: May 28, 2009 Realty Times

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