Paying Out of Savings: How Deep Must the Borrower Dig?
June 8, 2009

As the unemployment rate rises, more mortgage borrowers must choose between default and making the payment out of savings. That can be an agonizing decision.

 

“I was laid off recently but am reasonably hopeful of finding another position soon... We have stayed current by drawing down our IRAs, but there is only about $4,000 left, enough to cover us for one more month..Our family is counseling us to keep the $4K left in our IRA’s and not make the next monthly mortgage payments. Do you agree?”

     Not making the payment will hurt your credit, but if the choice is between missing the payment this month and missing it next month, I would miss it this month and keep the cash. I would only use the rest of your cash to make the payment if you manage to get a job before 30 days after the payment due date. In that event, you have a reasonable hope of being able to work your way out of the jam you are in, so using your remaining money to save your credit makes sense.

     This question is heavily value-laden, which is why I answered it in terms of what I would do, which is not necessarily what someone else with different values might elect to do. Some, and especially investors, could take the position that a borrower is morally obliged to make the payment if there is any possible way to do it. This is a defensible argument, but it assumes that the borrower’s only duty is to the investor. The borrower in question has a family to consider as well.

Requirement to Pay Out of Savings Under MHA

The issue of a borrower’s obligation to continue making payments out of savings after their income-generating capacity has been impaired arises in connection with the Government’s Home Affordability Modification Program (MHA).

“I have applied to have my loan modified, and am in process of filling out the financial questionnaire that my servicer sent me. It asks for the amounts in my bank accounts. Although my income has dropped, I have enough money in the bank to cover the mortgage payment for 3 years. Should I take it out, and where should I put it?”

To be eligible to have your payment reduced under this program, you must document not only that your income is insufficient to meet the payment, but also that you do not have “sufficient liquid assets” to make the payment. I have scrutinized the specs for this program issued by Treasury, and could not find a definition of either “sufficient” or “liquid assets.” It is a thorny issue that Treasury elected not to deal with. In effect, this leaves it up to the servicers to decide, raising the prospect of widely divergent approaches.

Don’t expect me to advise you on how to avoid the intent of this regulation, but I am willing to advise Treasury on how it might have created greater certainty in the rule by defining terms. I would define “liquid assets” as deposits without a specific term plus money market funds, and “sufficient” as an amount exceeding 6 months of payments.

My guess is that few if any borrowers are going to get caught by the “sufficient liquid assets” rule, that Treasury knows this and put the rule in to cover its backside. It does not want to read press reports about a borrower with millions in the bank successfully obtaining a rate reduction. If it happens, it can be blamed on the servicer. From this standpoint, leaving the rule undefined makes perfect sense. 

Modification Not a Remedy For Unemployment

 

“I had been making 130K annually, but I was laid off in February and now draw unemployment insurance of $1420 monthly. Our mortgage company says that we don’t qualify for a loan modification and to come back after we are 60 days past due. Why is that?”

 

The purpose of a loan modification is to lower the payment (including property taxes and homeowners insurance) to the point where it is affordable, defined as comprising no more than 31% of the borrower’s gross income. But there is a limit to how far the payment can be reduced, arising from the requirement that the modified loan must be worth more to the investor than it would if it went to foreclosure. Because your only income now is from unemployment insurance, the servicer concluded that your mortgage would be worth more if it were foreclosed.

Working backwards from the figures you sent me, a modification that reduced the rate on your first mortgage to 2%, which is the lower limit to a rate reduction, would result in a payment-to-income ratio of 31% if you had an annual income of about $55,000. This is less than half of what you were making, and suggests that one way to save your house, and perhaps the only way, is to lower your sights on what you are prepared to accept in the job market.

 
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