The main problem I see with this whole process of a loan modification, at least what is
generally being offered, it is not needed and of little use to a homeowner.  If a homeowner
owes 400k on a home that is worth 200k, lowering their interest rate does not help the
homeowner in relation to their circumstances.  Sure, one can argue their cash flow might
improve but there are better ways to improve cash flow.

The current loss illustrated above, is not the homeowners, it is the lenders (really the
underlying holder of the securities being serviced by the bank).  It is a lie in the process to
get the poor homeowner to pay the loss for that lender under the disguise of assistance
and they abuse the homeowner in the process my getting them to provide a ton of
paperwork and mess with them for months to do it.  They say that they are helping the
homeowner, in the ending, they are only helping themselves have little to no concern for the
homeowner.

Assume:  Homeowner owes $400,000.00 on a home that is now worth $200,000.00.  The
loan of $400,000.00 has an interest rate of 6.5%  The homeowner has reached out to their
lender and is now offered a loan modification for an interest rate of 4.5%.  This scenario
achieves the following:

Current mortgage: $400,000.00 @ 6.5% = $2,528.27 per month.

Modified mortgage: $400,000.00 @ 4.5% = $2,026.74 per month.

Savings of ~$500.00 per month. On the surface, saving $500.00 per month sounds like a
good deal, but is it?

Since the asset is worth only $200,000.00, consider the various interest rates for a term of
30 years:

6.5% rate gives a payment of $1,264.14.

8.5% rate gives a payment of $1,537.83.

12.0% rate gives a payment of $2,057.23, similar to modified payment proposed.

15% rate gives a payment of $2,528.89, similar to current mortgage payment.

In effect, the current lender is asking you pay a cash flow to them on an asset worth
$200,000.00 with the modified loan at 12% or at the current monthly payment at 15%.  This
assumes that you pay your mortgage for a total of 30 years (however, who pays for 30
years??? More about that shortly). Paying a mortgage at those rates makes no sense.

Accepting Loan Modification Cash Flow Analysis ($200,000.00 value):

30 years with a payment of $2,026.74 yielding 11.933% for a total of payments of
$729,626.40.

30 years with a payoff at 10 years with a payment of $2,026.74 requires a $319,532.34
payoff yielding 14.933% for a total of payments of $562,741.14.

30 years with a payoff at 5 years with a payment of $2,026.74 requires a $363,972.30 payoff
yielding 21.616% for a total of payments of $485,576.70.

This analysis is important.  It would be rare that a consumer will actually go longer than 10
years with a modified loan and realistically it will end up being refinanced or the property
sold somewhere between 5 to 10 years.  That would mean the consumer will end up
paying somewhere between 15% to almost 22%.

However, if the homeowner becomes a renter, consider this cash flow analysis:

Renting for various periods:

Renting for 10 years with rent for years 1-3 at $1,600.00 at years 4-6 at $1,750.00 at years 7-
10 at $1,850.00 would be a total of payments of $213,000.00.

Renting for 5 years with rent for years 1-3 at $1,600.00 at years 4-5 at $1,750.00 would be a
total of payments of $99,600.00.

Of course, none of this assumes any increase in value for the underlying property being
owned nor any tax benefit.  Any increase in value over the next 5-10 years is highly
speculative and even a 5% increase per year still does not impact the 10 year projection in
any real favorable ways.  As consumers grasp this concept, the results could be dramatic.

Using that analysis to one’s advantage is to first admit something, it’s pretty much true.  In
that truth, where is the opportunity?

Oddly, a form of sub-prime.  The real estate and finance industry should band together to
forget all the short sales and loan modifications and instead focus on a product that allows
those homeowners who have lost their homes or about to lose those homes into a
purchase money loan product that allows them to buy a similar home in their
neighborhood at the $200,000.00 value instead of the $400,000.00 they pay now.  It would
be better for them to pay 10% interest on a new loan than to accept that loan mod.  It’s not
sub-prime… it’s a real fresh start.



(c) 2009, David A. Pereira
The Business Case of Walking Away!
By David A. Pereira (July 2009)
Law Office of Kimberlee A. Rode
- Mortgage Litigation Consultants -