A Win-Win Modification For Southwest Florida

I have been offering foreclosure avoidance and mitigation counseling on a pro-bono basis in Southwest Florida for more than a year, both in conjunction with a Florida Bar-sponsored program and through my church.

A typical counseling fact situation is something like the following:

The homeowners are a married couple in their mid-30s. They purchased a home in Cape Coral in 2007 for $200,000. Their monthly payment of principal, interest, taxes and insurance is about $1,800 per month.

They were subprime borrowers and paid nothing down. Their credit was marginal and they had no reserves to fall back on should the need arise.

The market value of the house today is about $60,000, leaving them some $140,000 upside down.

The wife has a high-school education and is working as a clerk in a retail store. The husband was employed in a construction related activity and with construction coming to a halt, has been out of work for a year. He finds a day's work here and there, but has been unable to find a job and has no near term prospect of finding one. Between the two of them, they are now earning about $2,000 per month.

The homeowners are now three months behind in their mortgage payments and they have accumulated something in the neighborhood of $50,000 in consumer debts, mostly credit cards. They are willing to give a deed in foreclosure, participate in a short sale or cooperate in a friendly foreclosure.

These alternatives will leave the lender with a house worth about $60,000 (about $54,000 after sale) and an uncollectible deficiency of about $146,000 and leaves the homeowners with no home and no credit.

The homeowners don't qualify for a Making Home Affordable Refinance because the home is so far upside down and they are in default. The Making Home Affordable Modification is not attractive to either the lender or the homeowner, because 31% of $2,000 per month, minus taxes and insurance of about $200 per month, leaves only $420 per month for principal and interest.

That will service only about $70,000, which would leave the balance of the mortgage ($200,000 - $70,000 = $130,000) to be repaid at the time of resale.

The value of this house should "stabilize" at about $150,000, but that could take as long as 10 years to reach that figure.

A modification like this leaves the homeowners with little incentive and they may see a deed in foreclosure, a short sale or foreclosure as a better way to put this behind them. If they have family support, they can go across the street and by the same home for $60,000, with family guarantees.

I have proposed an alternative to loan servicing agents with no success that would keep the homeowners in the home and give them a financial incentive to stay there and at the same time should be more attractive to the lender than a deed-in-lieu, short-sale or foreclosure. My proposal is a loan modification that works like this:

1. Divide the note and mortgage into two parts. A fixed portion in the amount of 115% of the current vale of the home and a contingent portion in the amount of the balance owing the lender.

2. The fixed portion would be amortized at current rates (say 5%) over 30 years.

3. The contingent portion would not accrue interest but be paid at the time of resale of the property by the homeowners at the rate of one-half of the excess of the net sales price over the initial amount of the fixed portion of the modified note and mortgage.

4. If the homeowners live up to their commitment under the modification for three years, the modification would become permanent.

If not, the lender would have the option to disregard the modification and take such action as the lender deems appropriate.

My experience in banking tells me that this would be a better result for both the lender and the homeowners than those of a deed-in-lieu, short sale or foreclosure.

One thing that make this alternative unattractive to the lenders is the tax treatment of the modification.

If the lender acquires the property and sells it or forecloses on the property, it is able to deduct the loss they realize.

If the lender makes the modification I propose, there is probably no deduction for the loss until the property is sold and the total amount of the loss can be calculated.

A change in the tax laws may save homes.

Mr. Johnson is a real estate attorney and broker in Fort Myers, Fla.

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