In the past, when a homeowner began to miss mortgage payments and got behind on his loan, the natural process resulted in foreclosure. There was no consistent set of guidelines for lenders to follow when a borrower missed a payment, so they continued to add the missed payment and a late fee to the principal of the loan and carried on. This did not help the homeowners who was obviously struggling. Today, with the introduction of the President's Making Home Affordable plan, there are clear, detailed instructions for lenders to follow in order to provide a loan modification for struggling homeowners who cannot meet their monthly mortgage obligations.
The aim of this program is to modify the loan agreement so that the borrower pays no more than 31% of his monthly income on his mortgage. When negotiating with a borrower who is in danger of falling behind on his payments or who is facing the foreclosure of his home, lenders now have an understandable, uniform set of guidelines to follow. These instructions are known as the Standard Waterfall. Following the Standard Waterfall, here are the steps the lender will take:
1. Request to know the borrower's gross monthly income and verify it through past tax returns.
2. Calculate the homeowner's current monthly mortgage payment including all fees and insurance. Late fees are not included in this number.
3. Calculate 31% of the gross monthly income. This is the targeted debt-to-income (DTI) ratio.
4. Reduce the interest rate in 0.125% increments to find a payment that is as close to the targeted DTI as possible. However, the lender does not have to go below a 2% interest rate.
5. If the targeted 31% goal cannot be reached, the length of the loan may be extended to be up to 40 years long.
6. If the 31% goal still cannot be met, the lender can, but does not have to, start to forbear principle. This means a specific amount will be due in one payment at the end of the loan.
Lenders are encouraged to perform loan modifications through incentive payments for each one they do. If they follow the above steps, do a cost analysis and then find that the incentive payment will give them more money than they would get with a foreclosure, they will modify the loan. After trying the new payments out for three months, the interest rate is then locked in for five years.
Now lenders have a clear set of loan modification guidelines to follow, the Standard Waterfall, when they are trying to help homeowners secure a loan modification.