Mortgage Note Investing: Loan Modifications Best Practices
Loan modifications are generally offered to borrowers that have gotten off track at some point, but they want to stay in the home and begin paying again. To accomplish this as a lender, it is generally necessary to offer more attractive terms to the borrower than they agreed to on the original note. In some cases, similar conditions may apply, but there’s some forgiveness or deferral of past due amounts to incentivize the borrower to resume paying.
A common approach to modifying a loan involves a rate reduction. Some lenders fail to realize though the impact of setting the rate too low. Not only does it lower the noteholder’s investment yield, but it also can hurt the ability to sell the note to another investor. I’ve seen a lot of 2% modified note rates that were fixed to maturity, and the lender thought it was a good idea because they would get the loan paying again. They then realized that when they tried to sell the loan, the yield was so unattractive nobody wanted to buy the loan.
Another pitfall to modifying loans can be where you set the maturity date. Some lenders will extend the maturity date out 40 years because it makes it possible for the payment to be low enough for the borrower. However, many note investors frown upon this, and they will not want to own a note with a remaining term that’s over 30 years or over 360 months out. It’s essential to understand how the modified maturity date can impact the demand for your note. When borrowers are behind on the mortgage, they’re also delinquent on taxes many times, and when modifying a loan, it’s smart to bring the taxes current as a condition of the modification. Many lenders solely focus on getting the borrower back on track with the mortgage, and they neglect to address the back taxes or liens that can jeopardize the lender’s position if those taxes were to go to sale or they’re not redeemed on time. Some lenders will continue to offer modification after modification throughout owning the loan.
Each lender has to determine what makes the most sense for their portfolio, but when it comes to selling a loan, a borrower that has been a serial defaulter is frowned upon by note investors. Finally, a trial modification can be an excellent way to see if a borrower is going to perform before you extend a permanent change. This consists of requiring the borrower to make at least three to six on-time payments before the permanent modification is executed.
One, be mindful of modifying the note rate to loan. It’s generally wise to clean up back taxes as a condition of the modification. Be careful about extending the maturity date beyond 30 years. Recognize that multiple modifications can result in increased credit risk when selling the loan. Finally, trial modifications can be a significant prerequisite before permanently modifying the loan.
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