This article about loan modifications was passed along to me by Morgan Brown from Blown Mortgage. It’s a must read if you’re thinking about asking for a loan modification from your bank/lender.
Loan Modification Math
Too many people considering whether loan modifications are right for them or not don’t know where to start. They have no idea how to tell if they have a chance to qualify or not. With the changing laws and programs for loan modifications you certainly can’t be blamed if you’re not exactly sure if you qualify for a loan modification. In this post we’re going to give you some general guidelines on what you’ll need in order to qualify for a loan modification for your home.
Please note: these are general guidelines. Each bank has its own requirements and each situation, including yours, is unique. Contact your bank for exact requirements for loan modifications for your situation.
How do I know if I qualify for a loan modification?
The bank is trying to ascertain, once they go through the hassle of getting your loan modified, how likely it is that you’ll go delinquent on your mortgage once again. Redefault rate is a hot topic right now for good reason. The government, the banks and investors are all taking a risk in that by putting money up for loan modifications they’re hoping the foreclosure tide is stemmed. Therefore, banks want to know that when they make a modification it will stick.
This is the key step in determining whether you’ll be able to qualify for a loan modification or not. Can you stay current once your loan is modified? That’s the question – and for the banks, it’s all in the math.
So how can I figure out the math behind qualifying for a loan modification?
If you remember when you bought your home, you went through a qualification process. At one point in the process you were asked for a copy of your credit report, your income documentation and copies of any major debts that you had not listed on your credit report. The person processing your home loan calculated what is known as a debt to income ratio or DTI. This ratio determines how much of your gross monthly income (dollar amount before taxes) is consumed by your house payment and your other monthly obligations like cars, credit cards, student loans, etc.
The debt to income ratio is once again king in determining your ability to qualify for a loan modification. So it’s time to break out your calculators:
Let’s show how to calculate this via an example…
Example mortgage calculation
Say you have a $165,000 mortgage that recently adjusted from 5.25% to 9.25%. Your situation would look like this:
- Loan amount: $165,000
- Term: 30-years
- Interest rate: 5.25%
- Monthly payment: $911.14
- Loan amount: $165,000
- Term: 30-years
- Interest rate: 9.25%
- Monthly payment: $1357.41
Lets say that you’re still making that $60,000 per year and that you had total monthly expenses (not counting your mortgage) of $1,800 per month.
Your DTI prior to adjustment:
- $1,800 + $911.14 = $2,711.14 / $5,000 = 54.23%
Your DTI after adjustment:
- $1,800 + $1,357.41 = $3,157.41 / $5,000 = 63.15%
Million dollar question: What is the RIGHT DTI?
Banks have tightened what they think is an acceptable credit risk – they’ve dialed it way down. And while it varies from bank to bank, the target DTI you should be looking for in hopes of qualifying is 50%.
If you can show a DTI of 50% or less via a loan modification to a lower interest rate, you stand a good chance of qualifying for the modification.
Note: In the above example this would mean getting an interest rate reduction below the original start rate of the loan (5.25%). Reducing the loan to its original note rate of 5.25% would leave you with a DTI of 54% - which falls above the 50% rule of thumb.
How can we give ourselves a shot at qualifying for a loan modification?
- Double check our expenses for items that shouldn’t be included (such as work-related expenses)
- Call our credit card companies and ask for a reduction in monthly payments
- Reduce our utility bills by cancelling premium cable subscriptions, opting in to programs that reduce utility bills in exchange for power-flexibility in the summer, switching to a smaller trash can size, etc.
- Exclude expenses like eating out, food, clothes and discretionary expenses from your DTI
Because your monthly expenses can fluctuate quite a bit each month you want to focus on big ticket items and not rack up lots of little dings.
What if we:
- Saved $300/month by not eating out
- Cancelled a gym membership worth $100/month
- Reduced our utilities by $50/month
That would give us a DTI of: 45.22% - bingo. That’s the number we want to work with.
Finally, we’re going to report the big ticket items that are always there, but we’re going to leave off for now the variable items that we can control, such as food, etc.
If they ask for it later we’ll give it to them; but for now we want to present a case that with a new “hoped for” mortgage amount (the modified rate and monthly payment) plus our monthly expenses that we’re a good candidate for a mortgage at under 50%.
This is the number we’ll end up calculating on the monthly expense worksheet that we’ll have to prepare for the bank. You can get a free copy of a sample loan modification monthly expense worksheet that you can use to calculate your DTI.
Tip: Never lie to your bank. What we’re doing here is making an assumption that we can control variable monthly expenses through good judgment and sacrifice in order to keep our home. If we must present this information we will.
A shot at a loan modification
With a sub-50% debt to income ratio in hand you’re a good candidate for a loan modification. If you’d like more loan modification tips and strategies please join our mailing list. You’ll receive a free report just for joining: “The 10 Deadliest Loan Modification Mistakes” you must avoid at all costs. You’ll also get our free pamphlet, Loan Modifications 101.