1. What is a “workout”?
2. What options exist for a borrower and lender when a loan is in default?
3. What is a Repayment Plan?
4. What is Loan Forbearance?
5. What is a Loan Modification?
6. What is a Loan Assumption?
7. What is a Pre-Foreclosure Sale?
8. What is a Deed in Lieu of Foreclosure?
9. What happens if the lender and borrower cannot work out an agreeable plan for the loan?
10. What is HAMP?
The term “workout” is used to define a more formal modification of debt which is mutually-negotiated by the borrower and lender. A workout is an agreement by the parties which avoids a bankruptcy filing. Simply, the agreement is one between the borrower and one or more of his or her creditors for the payment of the debts between them. A workout may be one agreement between a borrower and one of his or her creditors, or it may be part of a more comprehensive debt restructuring plan that involves many creditors.
2. What options exist for a borrower and lender when a loan is in default?
When a lender and borrower are seeking solutions for a loan in default, many options exist. These solutions range from a repayment plan, to foreclosure, or even the borrower’s bankruptcy. Foreclosures are often costly for lenders and borrowers, and there may be benefits to keeping the borrower in the home or other property. Often lenders are willing to work out a defaulted loan.
Workouts encompass many different options and each workout is different. Some common approaches to structuring a loan workout, which are explained more fully below, are: repayment plans, loan forbearance, loan modification, loan assumption, pre-foreclosure sale, and deeds in lieu of foreclosure. Before agreeing on a workout option, many lenders may require the borrower to prove that he or she can ultimately pay off the renegotiated loan. The lender will only agree to a workout arrangement if it is satisfied that the arrangement is in its best interest.
It is often advisable to approach the lender early, after the first sign of financial trouble appears. Waiting until the lender begins sending payment demand letters often seriously impairs the chances of working out a successful renegotiation plan.
A repayment plan is a formal or informal plan to repay the lender all of the overdue amounts and fees over a period of time. The plan usually requires monthly payments to the lender for the overdue amounts, while still requiring payment of the borrower’s regular monthly payment. Most lenders seek to ensure that the borrower will be able to overcome the temporary hardship causing the delinquency and will be able to make future loan payments.
Forbearance occurs when a lender agrees to reduce or suspend payments for a period of time. This is common when the borrower suffers a temporary financial setback, but anticipates a resumption of income after a period of time, enabling the borrower to resume payments.
5. What is a Loan Modification?
Loan Modification is the process by which a lender modifies certain terms of the existing loan to resolve default for a longer period of time. This is common when the borrower experiences a financial setback that is likely to persist for an extended period of time.
Several options exist in a loan modification. The lender may agree to modify the term of the loan (or the length of the repayment period), the interest rate, loan balance, or to reduce monthly payment amounts.
Other options that exist which may be used in conjunction with Loan Modification or other approaches, such as Repayment Plans, include forgiveness of past due payments, late payments, or overdue interest. Additionally, the lender may be willing to add these amounts to the principal of the loan (this is known as “capitalizing” these amounts) so that these amounts may be repaid over the life of the loan.
A Loan Assumption occurs when the lender allows a new borrower to assume the payments on the loan. This may happen when the loan cannot be brought current and kept current by the original borrower.
7. What is a Pre-Foreclosure Sale?
A Pre-Foreclosure Sale is also known as a “short sale.” This occurs when the property securing the loan is sold prior to foreclosure. Often the proceeds of the loan are not enough to fully repay the loan (this is true because the amount due on the loan is more than the property is worth). The lender agrees to accept the lower payment in exchange for release of the indebtedness.
8. What is a Deed in Lieu of Foreclosure?
A lender may agree to accept title to the property securing the loan in exchange for a release of the borrower’s indebtedness on the loan. This is called a deed in lieu of foreclosure. This may not be an acceptable option to the lender if title issues exist on the property or if other loans have been taken out against the property (for example, if there is a second mortgage on a home made by a different lender or if tax liens exist against the property).
9. What happens if the lender and borrower cannot work out an agreeable plan for the loan?
If the lender and borrower cannot work out an agreement regarding the loan, and the loan remains in default, the lender may foreclose on the property securing the loan. Most loan documents contain provisions which allow the lender to foreclose without judicial process. The law requires, upon default, the lender to give notice to the borrower of impending foreclosure. The bank must publish notice of the time and place of the foreclosure sale.
The borrower may also consider bankruptcy. If the borrower is in default, filing bankruptcy would prevent any further collection action, including foreclosure, against the borrower during the pendency of the bankruptcy proceedings.
The Home Affordable Modification Program (HAMP) is a uniform loan modification program which provides eligible borrowers with affordable monthly payments. The program is available to borrowers who are in default or who are at imminent risk of default. Not all lenders participate in this program.
The program is eligible to borrowers whose currently monthly mortgage payment is greater than 31% of their income, have verified monthly income, and are able to document long-term or permanent hardship.
The program modifies the borrower’s monthly payment by taking several steps including: capitalizing past due amounts, reducing interest rates, extending the payment time frame, and deferring payment of principal. The modification brings the payments down to 31% of the borrower’s gross monthly income. The borrower must successfully complete a trial payment period before the loan is modified.