Demand for Loan Modifications Continues
CUs are finding creative ways to adjust member debt payments during tough times.
Although the economy and housing markets show signs of slow improvement, many credit unions face a slew of requests from members to modify loans and consumer debt—particularly mortgages.
Many factors are contributing to this trend, including persistent unemployment, massive layoffs, and a slow housing market that makes it difficult for mortgage-holders to unload houses they can no longer afford. In some markets, real estate values have plummeted as much as 50% to 70%. Meanwhile, the national average unemployment rate hovers around 10%.
- The reasons for a formal loan modification policy and set of procedures, and who to consult in their formation;
- The difference between documented hardship and negative equity;
- Tools and options for loan modification;
- A brief overview of the Home Affordable Mortgage Program (HAMP);
- The basics of determining Troubled Debt Restructuring (TDR) loans;
- Analysis of loan modification applications and accompanying documentation;
- Factors associated with successful repayment of modified loans; and
- Tracking of loan modifications.
Two primary advantages of performing loan modifications, notes the white paper are:
- The ability to retain loans within the credit union’s portfolio; and
- The avoidance of foreclosure costs when loan modification proves to be less expensive.
“Loan modification is an option to assist the member through a period of temporary (or sometimes permanent) financial setback,” suggests the whitepaper. “It allows the credit union to retain the loan, and in the case of a home loan, avoid foreclosing on a possibly declining asset while also assuming expensive foreclosure costs.
“Ideally, the credit union wants the member to retain his or her house or car and will do whatever it can to assist the member to continue to make payments on the loan. This is particularly true for members who have a documented hardship such as loss of a job.”
A credit union’s margins, however, aren’t the same as those of most big banks, it notes. When members have lower interest rates, the credit union has less flexibility to dramatically alter the terms of the loan. Further, as a financial cooperative, it must protect the collective assets of its membership, abide by safe and sound lending practices, and adhere to the guidelines and requirements of the National Credit Union Administration (NCUA) and its examiners.
This often means the credit union must turn down members who can still afford their monthly payments even though their loans are for more than the current real estate value of the home.
Next: Loan modification options
Loan modification options
When credit unions can perform loan modifications for members, the options include:
• Temporary forbearance. This is often the first option granted to borrowers. During a limited time period, usually three to six months, the lender reduces the borrower’s payments to a realistic affordable amount, based on income and existing obligations. These payments might include principal and a reduced interest rate or interest only.
• Stretched loan. This means extending the term of the loan and the maturity date. For example, suppose a member has paid two years on a car loan and has three years’ balance left to pay. The credit union can extend the term of the loan back to five years and stretch the balance remaining out over five years to reduce the payment. In the case of a house, if the member has a 10-year mortgage with a high balance remaining, the credit union might extend the term to 30 years—again to reduce the monthly payment.
• Reduced interest rate. Credit unions usually offer this option for no more than one to five years before mandatory review is required. This ensures the credit union won’t get locked into a low interest rate for an extended period of time in relation to market interest rates.
• Mortgage conversion. This usually involves converting from an adjustable-rate mortgage to a fixed-rate mortgage.
• Combined debt. The credit union combines the member’s secured and unsecured debt into one new loan with an affordable monthly payment, based on income and obligations. If a member has both a mortgage and an outstanding balance on a credit union credit card, for example, the credit union might take the card balance and add it to the house loan. In this way, the member pays a lower interest rate on secured debt.
• Waived late fees.
• Reduced or capitalized past due amounts, accrued interest, taxes, insurance, or fees.
Other, less commonly pursued options include:
• Stepped payment plan. For example, the credit union might greatly reduce the rate and/or the monthly payment during the first year of the mortgage, increase it the second year, and then return it to the original rate/payment amount in the third year.
• Principal forbearance. NCUA defines this as “a loan modification where the lender reduces the unpaid principal balance of a loan for amortization purposes. The borrower’s monthly loan payment is lower, based on amortizing the reduced amount of principal. But the borrower still owes the ‘postponed’ principal when the loan is paid in full or the property is sold or refinanced.”
• Reduction or forgiveness of principal. The lender agrees to wipe a portion of the unpaid principal off the books. For instance, say the borrower took out a $300,000 mortgage, and paid $50,000 on the balance, including interest. The borrower wants the principal reduced to $150,000, the current fair market value of the house. If the credit union does this, it will take a hit both on the principle and the interest. In some instances, however, this might be preferable to foreclosing and possibly getting significantly less than the $250,000 owed.
Next: Compliance and accounting guidelines
Compliance and accounting guidelines
The council whitepaper also provides compliance and accounting suggestions for handling loan modifications, which can be tricky.
“A credit union pursuing a loan modification initiative or program,” it notes, “should consult with its credit union examiner, CPA [certified public accountant], legal counsel, and NCUA to build policy and procedures that protect the credit union and its membership’s collective assets. This is to ensure that loan modification requests are treated fairly and objectively, and when approved, don’t violate the credit union’s practices for safety and soundness.”
Three factors are critical to the successful payment of modified loans. Members must:
- Have the desire and intention to keep the asset or property;
- Cut down on optional lifestyle expenses; and
- Understand, through education provided by the credit union and its financial counseling partner, the short- and long-term implications of defaulting on the loan or modified loan.
“Loan modification is an involved set of services to learn and implement,” notes the whitepaper. “However, credit unions are made up of members not investors, and some of these members are in honest need of assistance from the credit union, based on documented hardship.
“At the same time, credit unions need to retain member loans to stay in business and to thrive, long-term. It’s also vital that they educate members about the difference between banks and credit unions, in terms of interest rates and margins of flexibility, so members understand the reasons why the credit union approves certain loan modifications and not others.”
For more information or to access the white paper, visit cunalendingcouncil.org; select “tools and resources” and “whitepapers.”