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Mortgage Income Qualifying, Lender Forgiveness

The Mortgage Professor: Some tough questions

Sept. 17, 2015

By JACK GUTTENTAG The Mortgage Professor - Tribune News Service

Some of the questions I get from readers make me wince.

One reason is that I know the questioner is not going to be pleased with my answer.

The following letter -- edited for length and clarity -- could have been written by any one of the millions of borrowers who took out second mortgages before the financial crisis:

"Could you give me some pointers on negotiating a settlement on a second mortgage on my house in Florida, which has lost significant value? My situation is as follows: My first mortgage is for $105,000, the second for $118,000. The approximate current value of my home is $120,000.

I am currently not behind in payments on either mortgage. In fact, I am in a position that I am considering paying off the second mortgage and would like to see if I could do so at a reduced amount."

This borrower, like many others in similar circumstances, feels that the mortgage lender should share some of the pain resulting from the drop in house values. But borrowers never share their capital gain with the lender when house prices rise, so why should a lender share their capital loss when house prices decline? While the decline in house value has eliminated most of the equity supporting the second mortgage, it has not weakened the borrower's legal and moral obligation to repay that mortgage.

But this borrower was not interested in a lecture on repayment obligations. She wanted pointers on negotiating a deal.

So I gave her some.

I told her that so long as she was current on her payments, it was highly unlikely that the lender would negotiate anything. The fastest, and in many cases the only way, to get their attention was to stop paying, which would quickly cause the borrower's credit score to drop.

If she was pleading financial hardship, the lender might well negotiate ways to reduce the payment, perhaps including a drop in the interest rate.

But if she proposed a payoff for less than she owed, it is very likely that they would slam the door. In that case, she would have besmirched her credit for nothing.

I left the strongest argument against pursuing a negotiated settlement for last.

If she managed in some way to get the second mortgage lender to settle for less than full value, it would hit her credit in the same way as a foreclosure or bankruptcy. The decline in her credit score would be much greater than the decline stemming from a few missed payments, and the period required to recover her good credit would be significantly longer.

This letter made me wince for altogether different reasons.

"I am a 44-year-old, sick 9/11 volunteer first responder. I have been awarded a settlement of more than $1 million by the September 11th Victim Compensation Fund as a result of becoming ill after responding to 9/11 as a volunteer emergency medical technician. The amount I receive is expected to rise in 2016-2017, but I am not sure by how much. I have no employment income and am not expected to work again.

I would like to purchase a home as an inflation hedge and as a place to live. While I am now single, that may change, so the house will need to be large enough to house a wife and hopefully a child or two, and a service dog. Is it possible?"

If the amount the volunteer receives from the compensation fund is large enough, it would be possible for him to become a homeowner, even without an all-cash purchase.

The principal challenge is to generate the stable income stream he would need to qualify for a mortgage.

One way to do that is to purchase a fixed-payment annuity from an insurance company for a period equal to the term of the mortgage, say 15 years. A one-time cash payment of $1 million will buy him a monthly annuity income of about $6,700 for 15 years. If he allocated one-third of that to the payment on a 15-year mortgage loan at 4 percent, he could borrow about $300,000 to finance a purchase. The remaining two-thirds of the annuity income would be available for living expenses, but the income would cease after 15 years. At that point, he would be 59, only 3 years short of being eligible for a reverse mortgage on his house.

Nonetheless, he needs more than $1 million, plus a much more detailed financial plan, to make this happen. I invited him to contact me again when he gets a final reckoning on his settlement.

About the Writer
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.

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Copyright (c) 2015, The Mortgage Professor

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