The Most Common Benefit to the Homeowner is the Prevention of Foreclosure
Loss mitigation is used to describe a third party helping a homeowner, a division within a
bank that mitigates the loss of the bank, or a firm that handles the process of negotiation between a homeowner and the homeowner's lender. Loss mitigation works to negotiate mortgage terms for the homeowner that will prevent
foreclosure. These new terms are typically obtained through loan modification, short sale negotiation, short refinance negotiation,
deed in lieu of foreclosure, cash-for-keys negotiation, or a partial claim loan or other loan work-out. All of the options serve the same purpose, to stabilize the risk of loss the lender (investor) is in danger of realizing. The different options are available to homeowners to try getting the homeowner to "perform" (pay timely) and cure the potential loss the lender/investor projects incurring through the foreclosure process and auction sale of the property.
Kinds of loss mitigation
- Loan modification: This is a process whereby a homeowner's mortgage is modified and both lender and homeowner are bound by the new terms. The most common modifications are lowering the interest rate, reducing the principal balance, 'fixing' adjustable interest rates, increasing the loan term, forgiveness of payment defaults & Fees, or any combination of these.
- Short sale: This is a process whereby a lender accepts a payoff that is less than the principal balance of a homeowner's mortgage, in order to permit the homeowner to sell the home for the actual market value of the home. This specifically applies to homeowners that owe more on their mortgage than the property is worth. Without such a principal reduction the homeowner would not be able to sell the home.
Short refinance: This is a process whereby a lender reduces the principal balance of a homeowner's mortgage in order to permit the homeowner to refinance with a new lender. The reduction in principal is designed to meet the Loan-to-value guidelines of the new lender (which makes refinancing possible).
- Deed in lieu: A Deed in Lieu of foreclosure (DIL) is a disposition option in which a mortgagor voluntarily deeds collateral property in exchange for a release from all obligations under the mortgage. A DIL of foreclosure may not be accepted from mortgagors who can financially make their mortgage payments.
- Cash-for-keys negotiation: This is a variation of the deed in lieu of foreclosure. The difference is that the lender will actually pay the homeowner to vacate the home in a timely fashion without destroying the property. The lender does this to avoid incurring the additional expenses involved in evicting such homeowners.
- Special Forbearance - This is where you will make no monthly payment or a reduced monthly payment. Sometimes, the lender will ask you to be put on a repayment plan when the forbearance has been finished to pay back what you missed, while other times they just modify your loan.
- Partial Claim - Under the Partial Claim option, a mortgagee will advance funds on behalf of a mortgagor in an amount necessary to reinstate a delinquent loan (not to exceed the equivalent of 12 months PITI). The mortgagor will execute a promissory note and subordinate mortgage payable to United States Department of Housing and Urban Development(HUD). Currently, these promissory or "Partial Claim" notes assess no interest and are not due and payable until the mortgagor either pays off the first mortgage or no longer owns the property.
The most common benefit to the homeowner is the prevention of foreclosure because loss mitigation works to either relieve the homeowner of the mortgage obligation or create a mortgage resolution that is financially sustainable for the homeowner. Lenders benefit by mitigating the losses they would incur through foreclosing on the homeowner. Immediate foreclosure creates a tremendous financial burden on the lender. Loss mitigation allows the lender to take a lesser loss right now in order to avoid the much greater losses caused by such foreclosures.
History and causes
The examples and perspective in this section deal primarily with The United
States and do not represent a worldwide view of the subject.
Loss mitigation has been a tool used by lenders for decades, but experienced tremendous growth since late 2006. This rapid expansion was in response to the dramatic increase in foreclosures nationwide. Prior to late 2006, early 2007; Loss Mitigation was a tiny department within most lending institutions. In fact, the run up prior to the near collapse of the entire mortgage industry shows Loss Mitigation was almost nonexistent. The ten year period prior to 2007 spurred rapid year over year increases in home prices caused by low interest rates and low underwriting standards. Loss Mitigation was only needed for extreme cases due to the homeowners ability to repeatedly refinance and avoid defaulting.
Beginning in 2007 the mortgage industry nearly collapsed. Large numbers of lenders went out of business and the rest were forced to eliminate all of the loan programs that were most prone to foreclosure. These foreclosures were mostly caused by the packaging and selling of subprime and other risky mortgages. The transfer of ownership from mortgage lender to third party investor proved to be disastrous. Lenders wrote risky loans and sold them without being directly affected by the borrowers inability to pay. This practice prompted mortgage lenders to lower the requirements of mortgage approval to the lowest levels in history. This resulted in millions of unqualified people obtaining mortgages. Lenders sold pools of these loans to investment firms who packaged and resold them to the public in the form of bond issues. When the homeowners started to default on their mortgages and the bonds began to be considered too risky for investment, the investment houses could no longer sell the bonds. When the bonds stopped selling, the investment companies stopped purchasing newly originated mortgages. Lenders being unable to sell off the new mortgages, coupled with investment firms demanding that lenders buy back the bad loans previously sold, halted the regeneration of capital necessary to maintain the business of lending money. Well over 200 mortgage companies were either forced to close or go bankrupt. This crisis was dubbed the "Credit Crunch" and the subprime mortgage crisis.
With the surviving lenders faced with mounting losses from foreclosures, lenders were forced to tighten lending guidelines. This means people that were able to previously qualify for loans are now unable to do so. Many of these people are in risky subprime, adjustable rate and negative amortization loans are falling victim to dramatic payment increases. Without the ability to refinance out of these loans, the only answer for many is default and foreclosure or loss mitigation.
Unfortunately, many companies have emerged to take advantage of homeowners who are desperate. After a borrower misses their mortgage payments, a "notice of default" is filed at the county level. When this notice is filed, companies will contact homeowners making promises that they can modify the homeowner's loan and some companies even promise to get the principal amount reduced. This is a fraudulent claim, a 2008 study by Professor Alan M White found that of 4,342 modifications that he studied, only 62 received principal reductions. Homeowners should seek out the professional advice of nonprofit housing counselors and should be wary of paying a company $3,000.
The decrease in home values (housing correction) created a market with fewer qualified borrowers than homes for sale. When there is less demand the prices drop. Home values were at highly inflated levels prior to this due to historically low interest rates and the steady decline of credit requirements for the homeowner to qualify for a mortgage. This has led to a real loss of equity for every homeowner in the country. With less equity homeowners are less likely to qualify for a loan that will refinance them out of a risky loan; with less equity less homeowners are able to qualify for home equity line of credits or a second mortgage in order to pay for financial emergencies.
For many homeowners the loss of equity has been extreme enough to cause negative equity. Negative equity is when the home is worth less than the amount owed by the homeowner. This has created a situation for homeowners wherein their
home, which was previously their most valuable asset, is no longer an asset at all. Such homeowners are more and more frequently 'walking away' from their mortgage obligations and letting the home go into foreclosure.
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