Home Mortgage Modification Guide

The FDIC Loan Modification Program, attempts to reduce the homeowner's front-end debt-to-income ratio (DTI) using a standardized modification process. This process uses a net present value (NPV) tool to evaluate the merits of modifying each delinquent mortgage relative to foreclosure. If modifying a mortgage yields a positive NPV, the program mandates that a modification be initiated. Under the program, the following steps are taken to modify a mortgage:

1. Interest Rate Reduction: To reduce the home- owner's front-end DTI ratio to 38 percent, the servicer can reduce the interest rate on the mortgage, but the interest rate cannot fall below a floor of 3 percent.

2. Extended Amortization Term: If the home-owner's front-end DTI ratio still exceeds 38 percent after the interest rate on the mortgage has been adjusted, the mortgage will be amortized out to a maximum of 40 years, with a term no greater than 30 years.

3. Partial Payment Forebearance: If the home-owner's front-end DTI ratio still exceeds 38 percent, the last option is to split the debt into an interest-bearing, amortizing portion and a zero percent, zero payment portion of the loan. The repayment of the "postponed" principal will be due when the loan is paid in full.

One problem that this program encountered is the decline in house values. Lenders and servicers are unlikely to modify mortgages if they believe homeowners are likely to re-default. Declining house prices increase the risk of re-default because some borrowers are reluctant to continue making mortgage payments when their house value is declining, especially if they are "under water"; that is, the loan balance exceeds the current value of the home. When re-default is likely, the rational choice for a servicer is to initiate foreclosure proceedings when the homeowner becomes delinquent and sell the home at a sheriff's sale.